BUSI 530:
If the cost of an input it $1,000,000 this year; if you project inflation to be 3% annually, what would be an appropriate forecast for the cost of that input in year 4?
$1,125,508
A project generates revenues of $5,000, costs of $3,000 and taxes of $700. What is the project's operating cash flow?
$1,300 Reason: $5000 - $3,000 - $700 = $1,300
A project requires a $12 million initial investment and has expected after-tax cash flows of $2 million in perpetuity. The weighted-average cost of capital is 15%. What is the project's net present value (NPV)?
$1.33 million Reason: -$12 million + ($2 million/.15)=$1.33 million
If an investor purchases a security for $12.30, then sells it at a later date for $14.10, her capital gain would be ____________.
$1.80 Reason: $14.10 - $12.30 = $1.80
A project requires a $1 million initial investment and has an expected after-tax cash flow of $2.4 million per year in perpetuity. The weighted-average cost of capital (WACC) is 13%. What is the net present value (NPV) of the project?
$17.46 million Reason: NPV = -$1 million + ($2.4 million/.13) = $17.46 million
A project generates a net profit of $1.8 million and depreciation of $200,000. What is the project's operating cash flow?
$2 million Reason: Operating cash flow = net profit + depreciation = $2 million
A project has an initial investment of $1.4 million and a present value of cash flows totaling $4 million. What is the project's net present value (NPV)?
$2.6 million Reason: NPV=initial investment + PV of cash flows= -$1.4 million + 4 million = $2.6 million
U.S. Treasury securities are considered to be a risk-free investment that is fixed and not affected by movements in the market. Such a security would naturally have a beta of ______,
0
If you construct an investment portfolio by investing 75% of your funds in the market portfolio and 25% of your funds in Treasury bills, what is the beta of your portfolio?
0.75
Bonus depreciation is a temporary provision of the Tax Cuts and Jobs Act. It is scheduled to be phased-out starting in
2023
Select all that apply Which of the following will correct the effect of depreciation?
Operating Cash Flow = After-tax profit + depreciation Operating Cash Flow = (Revenues - cash expenses) X (1- tax rate) + (tax rate X deprecation) Operating Cash Flow = Net Income + depreciation
Select all that apply Which of the following formulas can be used to ensure that depreciation is not included in a project's operating cash flows?
Operating cash flow = (revenues - cash expenses) x (1-tax rate) + (tax rate x depreciation) Operating cash flow = revenues - cash expenses - taxes Operating cash flow = after-tax profit + depreciation
Which of the following statements is true regarding the risks undertaken by investors in U.S. Treasury bills?
Other than some uncertainty about inflation, they are nearly risk-free.
The correct equation for the Profitability Index (PI) is given by:
PI= NPV/initial investment
A company has the opportunity to invest in one of two mutually exclusive projects. Project A has an initial cost of $1.2 million and cash flows with a present value of $4.5 million. Project B has an initial cost of $2 million and cash flows with a present value of $5 million. Which project should the firm choose to invest in?
Project A because it has a higher net present value Reason: Project A has a higher NPV and is the correct choice: $4.5 million - $1.2 million = $3.3 million. The NPV for Project B is only $5 million - $2 million = $3 million
Which of the following is a solution to the problem of inconsistency in project forecasts?
Provide managers with a common set of economic and firm-specific indicators upon which to base forecasts
Select all that apply Which of the following accurately describes the accounting break-even point?
The level of sales at which profits are zero The level of sales at which total revenues equal total costs
Select all that apply Why is it that buying or selling financial securities in an efficient market is a zero NPV investment? Choose all that apply.
The price of a financial security in an efficient market is the present value of the expected future cash flows. Financial securities are priced at their true value and investors cannot make excess profit from the transaction.
The real option to expand helps to mitigate which of the following project risks faced by a firm?
The risk of making a large initial investment in full production for a project with uncertain cash flows.
According to the CAPM, what is the expected return on a stock if its beta is equal to zero?
The risk-free rate
Which of the following is the relevant risk to investors of a single stock held in a diversified portfolio?
The sensitivity of its returns to fluctuations in the overall stock market.
What is the legal consequence if the firm is unable to pay dividends to preferred stockholders?
There is no legal consequence as dividends are not a liability.
The standard deviation of returns is a useful measure of risk for individual assets in isolation, but is a misleading risk measure for assets in a portfolio due to the ________ effect caused by ________.
diversification; imperfect correlation of portfolio asset returns
Preferred stock is valued like a perpetuity. The price of a preferred stock is therefore equal to:
dividend/rpreferred
A sunk cost is irreversible; sunk costs
do not affect NPV and should be ignored.
Select all that apply Some examples of opportunity costs that should be included in project analysis are:
skilled employees who are moved from an existing project to the new project causing a loss to the existing project the market price of an asset that is committed to the project when it could have been sold for cash
A firm with high operating leverage will see that _____ changes in sales will lead to _______ changes in profits.
small, large
To estimate the future risk of a stock investment, analysts will calculate the _________ and assume it is a reasonable estimate of future risk.
standard deviation of historical returns for that stock
The measure of total risk for a security is its ________.
standard deviation of returns
The internal rate of return (IRR) is also called the:
discounted cash flow (DCF) rate of return
Diversification works best when portfolio stock returns are ______ correlated.
negatively
Which of the following best describes the NPV break-even point?
The level of project sales at which the NPV turns from negative to positive
Which of the following statements about working capital is correct?
a project may have WC outflows early, changing to inflows as WC is recovered
The ________ is usually accepted as a firm's cost of debt capital for WACC calculations.
promised yield to maturity on the firm's existing bonds
The ___________ method of project selection asks, "How long must the project last in order to offer a positive net present value?"
discounted-payback
Different classes of stock usually imply
disproportional voting rights
The initial cash flow at the start of a project's life is typically
negative
Andersen Corp will undertake a project that will produce cash flows of $50,000 in year 1, $60,000 in year 2, $70,000 in year 3, $75,000 in year 4 and $68,000 in year 5, what is the present value of those cash flows if Andersen's required rate of return on the project is 15 percent?
$211,562.53 Reason: 50000/(1.15) + 60000/(1.15)2 + 70000/(1.15)3 + 75000/(1.15)4 + 68000/(1.15)5 = $211,562.53
At the end of a project, a firm's investment has a salvage value of $4 million. The firm will pay taxes of $.5 million on the sale of the equipment from the investment. What is the net cash flow to the firm?
$3.5 million Reason: Net cash flow= salvage value - tax on gain= $4 million - $.5 million = $3.5 million
A project generates revenues of $1.4 million, cash expenses of $1 million, and taxes of $100,000. What is the operating cash flow?
$300,000 Reason: Operating cash flow = revenues - cash expenses - taxes = $1.4 million - $1 million - $100,000 = $300,000
Smith Industries plans to sell an asset at the end of a 5 year project for $250,000. The book value of the asset at that time will be $125,000. The marginal tax rate is 35 percent. How much tax will Smith pay on the sale, and what will be its net proceeds (cash inflow)?
$43,750; $206,250 Reason: Tax = (250000 - 125,000) x0.35= 43750; Net proceeds = 250000 - 43750
The average beta for all stocks (the beta of the market portfolio) is ____.
+1.0
If an investor purchases a security today for $9.00 and sells it tomorrow for $7.50, his capital gain will be _________.
--1.50 Reason: $7.50 - $9.00 = -$1.50
If you invest 50 percent of your funds in a stock with beta=1.5, 30 percent in a stock with beta=0.9 and 20 percent in a stock with beta=0.3, your portfolio beta will be _______.
1.08 Reason: (1.5)(0.50)+ (0.9)(0.30)+ (0.3)(0.20)=1.08
SkiFree Incorporated has $20 million of debt and $80 million of equity outstanding. The market cost of debt is 6% and the cost of equity is 12%. The firm has a 35% corporate tax rate. What is SkiFree's WACC?
10.38% Reason: (.2)(.65)6 + (.8)12 = 10.38%
The weighted average cost of capital is the expected rate of return investors would demand on a portfolio of:SkiFree Incorporated has $20 million of debt and $80 million of equity outstanding. The market cost of debt is 6% and the cost of equity is 12%. The firm has a 35% corporate tax rate. What is SkiFree's WACC?
10.38% Reason: (.2)(.65)6 + (.8)12 = 10.38%
Vandalay Industries has $30 million of debt, $10 million of preferred stock and $60 million of common stock outstanding. The market cost of debt is 8%, the cost of preferred is 9% and the cost of common equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
10.86% Reason: WACC = [$30/$100 x (1-.35)x8%] + ($10/$100 x 9%) +($60/$100 x 14%) = (0.3)(0.65).08+ (0.1).09 + (0.6).14 = 10.86%
The Tax Cuts and Jobs Act allows companies to take bonus depreciation sufficient to write off what percent of investment immediately?
100%
If you construct an investment portfolio by investing 75% of your funds in the market portfolio (r = 14%) and 25% of your funds in Treasury bills (r = 3%), what is the expected return of your portfolio according to the CAPM?
11.25 Reason: 3 + (14 - 3)(0.75)=11.25
Vandalay Industries has $30 million of debt and $70 million of equity outstanding. The market cost of debt is 8% and the cost of equity is 14%. The firm has a 35% corporate tax rate. What is Vandalay's WACC?
11.36% Reason: (0.3)(0.65)8.0 + (0.7)14.0 =11.36%
Martin Co. has issued preferred stock with an annual dividend of $6.00. The current market price per share of this preferred stock is $47.00. What is the expected return on the Martin preferred stock?
12.8% Reason: $6.00/$47.00=12.8%
Suppose the risk-free rate is 5%, the market rate of return is 10%, and beta is 2. Find the expected rate of return using the CAPM.
15% Reason: 5% + 2 × (10% - 5%)
Potter National Bank has a beta of 1.8. The risk-free rate is currently quoted at 1.5% and the expected market risk premium is 7.5%. What is Potter's cost of equity?
15.0% Reason: Cost of equity = risk-free rate + beta (expected market risk premium) = 1.5 + 1.8(7.5) = 15%
Once you have added about ______ or more diversified stocks to your portfolio, you have removed about as much specific risk as you possibly can.
30
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%? (Be sure to record the initial investment as a negative number.)
5.94 Reason: NPV = -$95 + ($107/1.06) = $5.94
Spock Enterprises has a market value of $100 million in debt outstanding. They also have a market value of equity of $400 million. Spock's total market value is ______ million.
500
If the expected return on Treasury bills for 2015 is 0.25 percent and the market risk premium for the U.S. is 7.50 percent, what is the expected return on the U.S. stock market for 2015?
7.75% Reason: 7.50% +0.25%=7.75%
When is a corporation legally obligated to pay dividends to preferred stockholders?
Never
Select all that apply Which of the following statements is true?
A higher firm tax rate means higher sales are required to achieve NPV break even A higher project depreciation means lower sales are required to achieve NPV break-even A higher initial investment requires a higher level of sales to achieve NPV break even
Which of the following is the correct definition of the Equivalent Annual Annuity (EAA)?
A stream of cash flows or payments that have the same present value as a project or investment's cash flows.
Project A has an initial investment of $10,000 and an NPV of $15,000. Project B has an initial investment of $100,000 and an NPV of $101,000. Based on the PI (Profitability Index), project _______ would be selected. Based on the NPV, project _______ would be accepted. Selecting project ______ will actually maximize shareholder value.
A; B; B
Which group of equity holders can participate in the election of the board of directors?
All common stockholders with a right to vote
It may make sense to time the decision to implement small positive NPV projects if their input prices are highly blank1.
Blank 1: volatile, variable, erratic, or unpredictable
If a project has blank 1 NPV, then the expected cash flows, discounted at the WACC, are just sufficient to provide returns debtholders and shareholders require.
Blank 1: zero or 0
The square root of variance is called standard .
Blank 1: deviation
The principal of blank1 demonstrates that a single stock that appears very risky may not contribute much to the overall risk of a well-diversified portfolio.
Blank 1: diversification
When considering the option to abandon, it is important to recognize that tangible assets are blank1 to sell than intangible ones.
Blank 1: easier
When manufacturers realize they are dependent on a single source of raw materials, they may seek out production facilities.
Blank 1: flexible
Value stocks here are defined as those with blank1 ratios of book value to market value; growth stocks are those with blank2 ratios of book to market value.
Blank 1: high Blank 2: low
The cost of capital used by firms should be based on blank 1 values of the firm's securities. (Use one word to fill in the blank.)
Blank 1: market
When calculating Blank 1Blank 1 net , Correct Unavailable Blank 2Blank 2 present , Correct Unavailable Blank 3Blank 3 value , Correct Unavailable, recognize investment expenditures when they occur, not according to a depreciation scheudle.
Blank 1: net Blank 2: present Blank 3: value
What is one necessary condition to use WACC to value an entire business?
The debt ratio will stay the same over time.
The firm's cost of equity is usually calculated using the _______ equation.
CAPM
Sensitivity analysis consists of which of the following activities?
Change the forecast of one cash flow variable at a time to observe effect on NPV
Making the choice to invest today or to postpone that investment to a future date is a choice between mutually exclusive projects. When making this choice, what is the correct criterion to use?
Choose the investment date that produces the highest NPV today.
Who enjoys the right to elect the board of directors in a corporation?
Common stockholders
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
Discounted payback period
Which of the following activities most accurately describes the technique of scenario analysis?
Examine changes to NPV due to changes to a set of consistent, interrelated variables
What is the CAPM formula?
Expected return = RF + beta × (RM- RF)
True or false: A sensible way for a manager to account for overoptimistic cash-flow forecasts is to adjust the discount rate.
False
True or false: Financing costs like interest and principal payments on borrowed funds must be included in the incremental cash flows for the project.
False
True or false: IRR is essentially the same as the opportunity cost of capital.
False
True or false: If a corporation uses cumulative voting and you are a minority shareholder who wants a seat on the board, you will prefer staggering.
False
True or false: Once the initial discounted cash flow analysis has been completed and a project has been budgeted and initiated, managers are no longer concerned about project cash flow forecasts.
False
True or false: it is acceptable to use book values of debt and equity to calculate the weights of debt and equity for the company cost of capital calculation.
False
True or false: the payback rule states that a project should be accepted if its payback period is greater than a specified cutoff period.
False
Select all that apply Why is it that a firm's capital investments can be positive NPV investments? Choose all that apply.
Firms may enjoy a monopoly advantage in their geographical area. Firms can exploit patents or exclusive technology to create competitive advantage. Firms can build customer recognition and loyalty for their products to generate repeat sales.
A firm is said to have high operating leverage if:
Fixed costs are high relative to variable costs
Recently, which of the following sources of funds has played the greatest role in the financing of U.S. nonfinancial firms?
Internal funds
Select all that apply Which of the following statements regarding the company cost of capital are true?
It is an opportunity cost. It is the minimum rate of return that the firm must earn on its average risk investments. It is used to value new assets that have the same risk as the existing ones.
Ensuring that forecasts are consistent is one of the challenges of the capital budgeting process. Which of the items below best describes sources of inconsistency in forecasts?
Managers have different expectations about the firm's future business and the economy
The single variable of interest for the investment timing problem is
NPV
Which of the following is the capital investment decision criterion that will always lead management to make the value-maximizing choice?
NPV
When there is no real capital rationing the preferred valuation metric is
NPV, because it will favor large projects over small ones.
A company has the opportunity to invest in one of two mutually exclusive projects. Project A has an initial cost of $1.2 million and cash flows with a present value of $4.5 million. Project B has an initial cost of $2 million and cash flows with a present value of $5 million. Which project should the firm choose to invest in?
Reason: Project A has a higher NPV and is the correct choice: $4.5 million - $1.2 million = $3.3 million. The NPV for Project B is only $5 million - $2 million = $3 million
Beating the performance of which of the indexes below is usually the definition of success for professional investors?
S&P 500
Who is entitled to any profits that are left after lenders have been paid?
Shareholders
Select all that apply If cash-forecasts are prepared properly then which of the following are true?
The discount rate should reflect only the market risk of the project. It cannot be fudged for forecasting errors.
Which of the following is the primary motive for creating dual or multiple classes of stock?
To maintain control of the firm
Indirect effects on cash flows may be positive or negative.
True
True or false: individual projects which seem risky to a firm do not contribute much risk to the portfolio of a diversified investor.
True
True or false: project discounted cash flow analysis assumes that cash flows occur at the end of the year even though they are actually spread through the year as sales and expenses actually occur.
True
True or false: the Standard & Poor's Composite Index is also referred to as the "S&P 500" index.
True
True or false: the market value and book value of debt are often very similar, so many financial managers use book value in WACC calculations.
True
What can management do to help ensure that they have a real option to abandon a project while maintaining a positive NPV?
Use project assets that are tangible and have a high value in secondhand markets.
Select all that apply Select all of the terms below that are related to the riskiness of an asset investment.
Variability of returns Volatility of returns Standard deviation of returns
The _______ break-even point is the level of sales at which profits are zero, or, equivalently, at which total revenues equal total costs.
accounting
Select all that apply When calculating NPV, why are cash flows discounted instead of accounting profits?
accounting profits do not recognize project investment expenditures as they occur income statements do not track cash flows using accounting profits gives an inaccurate NPV
Select all that apply The term incremental cash flow can best be defined as:
additional cash flows that will only be earned if the firm proceeds with an investment cash flow with the project minus firm cash flow without the project
The WACC is the return the company needs to earn after tax in order to satisfy
all its security holders
The weighted average cost of capital is the expected rate of return investors would demand on a portfolio of:
all the firm's outstanding securities
A benefit or cash flow foregone as a result of an action is called:
an opportunity cost
When a company bundles the cash flows from a group of loans and sells them, the resulting bond is called a(n) _________.
asset-backed bond
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for lower risk ones.
average; downward
The WACC is the appropriate discount rate for use with ______ projects but should be adjusted ______ for higher risk ones
average; upward;
The opportunity cost of capital for investment in the firm as a whole is called the:
company cost of capital
On a large and healthy firm, the use of yield to maturity as the cost of debt when calculating WACC is appropriate because
bankruptcy is sufficiently low.
Because interest payments on debt are paid out of _______ income and dividends are paid out of ________ income, debt has a tax advantage over equity.
before-tax; after-tax
The Profitability Index is also known as the ________.
benefit-cost ratio
The CAPM predicts that the difference in return between stock A and stock B should be due only to the difference in the _______ of the two stocks.
beta
The measure of market risk for a security is its _________.
beta
The risk of undertaking a project can be described by its __________.
beta
The analysis of the level of sales at which the project breaks even is:
break-even analysis
The limit set on the amount of funds available for investment is referred to as:
capital rationing
Select all that apply Which of the items below are the elements which must be included in the calculation of a project's total cash flow?
cash flow from capital investments operating cash flow cash flows from changes in working capita
Incremental cash flow is equal to:
cash flow with project - cash flow without project
To calculate net present value, you need to discount _________.
cash flows
To determine the equity value of an entire business, discount the firm's _____ using the ______ as the discount rate, then subtract the value of the firm's _____.
cash flows; WACC; debt
If the corporate tax rate is not zero, increasing the proportion of debt in the capital structure causes the WACC to _______.
change
Managers ask "what if" questions related to the factors that can increase or reduce project cash flows because ________.
changes in cash flows change NPV and may change the acceptability of a project
Another name for the WACC is the ___________
company cost of capital
Firms may use a ____________ to discount the cash flows of their average risk projects.
company cost of capital
The company cost of capital is calculated as a weighted average of the firm's _______ and _______.
debt; equity
A diagram of sequential decisions and possible outcomes that managers use to decide whether to expand is called a:
decision tree
If the market portfolio return decreases by 2%, then each firm's stock return will ________ by about _______ percent.
decrease; 2xbeta
Select all that apply Internally generated cash is calculated as a combination of:
depreciation retained earnings
Select all that apply Which of the following industries have less-than-average exposure to macro and market risk?
electric utilities grocery stores
The rate of return rule states that the rate of return is the discount rate at which NPV:
equals 0
The cash flow per period with the same present value as the cost of buying and operating a machine is called the:
equivalent annual annuity
The difference between the nominal discount rate and the real discount rate is ________.
expected inflation
Select all that apply Which of the following forecasted components of project cash flow should be adjusted directly to change with inflation from year to year?
expenses revenue
The increase in the rate that bondholders demand as the amount of debt borrowed increases is called the _______ cost of debt.
explicit
There are two costs of debt finance, the _______ cost and the _______ cost.
explicit; implicit
By keeping costs such as interest and principal payments on debt out of project cash flows, you are following a fundamental principle of corporate finance known as the separation of investment and ___________ decisions.
financing
A firm that is able to vary its output mix as demand changes is said to have:
flexible production facilities
Select all that apply Which of the following are commonly made mistakes that managers make in regard to working capital and forecasting project cash flows?
forgetting about working capital entirely forgetting that working capital may change during the life of the project forgetting that working capital is recovered at the end of the project
Debt that is repayable more than one year from the date of issue is called _______ debt, or _______ debt.
funded; long-term
Projects with high fixed costs will tend to have _______ betas than other projects.
higher
Since a risky dollar is worth less than a safe one, returns for risky projects must be ________ than those of a risk-free investment.
higher
Obtaining unbiased cash flow forecasts can be difficult because senior managers sometimes increase the ____________ for capital expenditures.
hurdle rate
Select which of the following relationships is correct:
if the opportunity cost of capital is less than a project's rate of return, then the NPV of the project is positive
The ______ cost of debt is the increase in the required return on common equity as the amount of debt borrowed increases.
implicit
If the market portfolio return increases by 1%, then each firm's stock return will ________ by about ________ percent.
increase; beta
The expected return on the stock market can be expressed as the sum of the _________ and a __________.
interest rate on Treasury bills; normal risk premium
Select all that apply Which two investment criterion methods are most used by firms?
internal rate of return net present value
Select all that apply Which of the following are true regarding the inclusion of working capital in project cash flows?
investment in working capital is a cash outflow recovery of working capital is a cash inflow invested working capital is recovered by the end of the project investment in working capital may change over the life of the project
Select all that apply The initial capital investment is a cash outflow at the start of the project that includes which of the following types of outflows:
investments in research and marketing required for the project any investment in fixed assets required by the project
The initial capital investment in a project requires a ______ cash flow. The salvage value from a project involves a ________ cash flow.
negative; positive
If choices you make today do not affect future investment opportunities, then
it is enough simply to compare the NPV of the projects.
Which of the following is the best definition of the firm's capital budget?
it is the list of the firm's planned investment projects for the coming year
Select all that apply Which of the following is true of a project's terminal cash flow?
it may be due to final cleanup or recovery costs it may be positive or negative It may be due to the sale of a project asset it may include recovery of working capital investment
When a project's cash flows are discounted at the WACC and the NPV is exactly zero, then those cash flows are _________ to give debtholders and shareholders the returns they require.
just enough
The most important measure of risk in a well-diversified portfolio is
macroeconomic risk
Investors holding well-diversified portoflios are most concerned with
macroeconomic risks
Select all that apply Which of the following are characteristics of sunk costs?
managers are often influenced by sunk costs they do not affect the project NPV they are past and irreversible cash outflows
The impact of macroeconomic news is tracked by the rate of return on a _____________ of all securities.
market portfolio
For a well-diversified investor, the only type of risk that matters is _______.
market risk
Select all that apply The total risk of a security investment consists of _______ plus _______.
market risk; diversifiable risk market risk; firm specific risk
Select all that apply Real options include the option to (choose 4):
modify postpone abandon expand
Projects with high fixed costs will tend to have earnings that vary _______ with any change in revenues
more
Increasing the amount debt makes debt ______ risky and equity _____ risky.
more, more
The most common type of asset-backed bond is backed by:
mortgages
If two projects (investments) A and B are said to be mutually exclusive then we know that the firm ______________.
must choose to invest in either A or B, but not both.
A staggered election occurs when:
only a fraction of the board are elected at a time
If a firm uses its book value of debt instead of its market value of debt to calculate its WACC, then its WACC will likely be:
only slightly off
Land that is used for a manufacturing facility could also be sold. The cost equals the cash that could be realized from selling the land now instead of using it for the manufacturing facility.
opportunity
The rate of return rule states that a firm should invest in any project offering a rate of return that is higher than the:
opportunity cost of capital
Unbiased cash flow forecasts are often difficult to obtain due to ________, which, despite causing higher projected cash flows, can also increase effort, commitment, and persistence from employees.
overoptimism
For well-diversified investors, the only relevant measure of investment risk is their __________.
portfolio beta
The average of the betas of the individual securities in a portfolio, weighted by the investment in each security, is called the:
portfolio beta
Select all that apply The total risk of a diversified portfolio of stocks is determined by the _________, since all ________ has been diversified away.
portfolio beta; firm specific risk portfolio beta; diversifiable risk
The total risk of a well-diversified portfolio of stocks can be calculated as the product of the ________ times the _________.
portfolio beta; standard deviation of the market portfolio
In simple cases of capital rationing, the _________ can tell a firm which projects to accept.
profitability index (PI)
A project's IRR measures the _________ whereas the opportunity cost of capital is equal to the ____________.
profitability of a project; return offered by equivalent-risk investments in the capital market
The minimum acceptable expected rate of return for a project is called the ________________.
project cost of capital
Select all that apply XYZ Industries is considering the following list of projects. For each, the project cost of capital and expected return are given. Which of these projects should the firm accept?
project cost of capital=7%; expected return=8% project cost of capital=12%; expected return=14.5% project cost of capital=9%; expected return=9.1%
Select all that apply Diversification of a stock portfolio can be achieved by __________.
purchasing stocks of companies across a wide variety of industries purchasing stocks whose returns are less than perfectly correlated
Conflicts of interest between shareholders and managers may cause managers to propose ________ projects over ________ projects.
quick payback; higher NPV
Select all that apply Which of the following statements about nominal versus real cash flows are correct?
real cash flows must be discounted by a real discount rate nominal cash flows must be discounted by a nominal discount rate
Options to invest in, modify, postpone, or dispose of a capital investment project are known as:
real options
Select all that apply Some examples of indirect effects that could affect incremental cash flows would be:
release of a product that will generate sales of replacement parts and services in future years cannibalization of existing product sales by introduction of a new product loss of existing store sales by locating a new store too close by increased sales of an existing product by release of a complementary product
If the corporate tax rate is zero, then increasing the proportion of debt in a firm's capital structure causes the WACC to _______.
remain unchanged
A project's operating cash flow can be calculated using which of the following equations:
revenues - costs - taxes
The opportunity cost of capital is determined by the ______ of a project.
risk
The security market line describes the expected returns and risks from dividing a portfolio between _________ and _________.
risk-free securities; the market portfolio
The make-or-break variable most commonly used in break-even analysis is ________; however, _______ can also be used to help a firm understand the break-even point.
sales volume; costs
Project analysis given different combinations of variables is called:
scenario analysis
Select all that apply Under which of the following situations should the IRR decision rule be avoided?
selection of mutually exclusive projects a project with multiple rates of return project NPV does not decline smoothly as discount rate increases
The analysis done to show the effects on project profitability of changes in sales, costs, and other variables is called:
sensitivity analysis
Most major corporations are owned by multiple investors, called __________.
shareholders
In principle the market portfolio should contain all assets in the world economy. In practice, financial analysts use _______ as a proxy for the market portfolio.
stock market indexes like the S&P500
The owners of most major corporations are called _________ or _________.
stockholders; shareholders
Since interest payments on debt are paid out of before-tax income, debt reduces the ________ of the firm.
tax liability
The cash flows brought about at the end of a project are called ________ and ________ be included in a project's cash flow forecasts.
terminal cash flows; should
The appropriate cost of capital to be used to discount risk-free projects is ________.
the Treasury bill rate of return
Select all that apply Which of the following are problems that managers may encounter when deciding between mutually exclusive projects?
the choice between short and long-lived equipment when equipment should be replaced the timing of investments
Which of the following are problems that managers may encounter when deciding between mutually exclusive projects?
the choice between short and long-lived equipment when equipment should be replaced the timing of investments
The Internal Rate of Return (IRR) can best be defined as:
the discount rate at which the NPV equals zero
The opportunity cost of capital can best be described as:
the expected rate of return given up by investing in a project rather than in the capital market
The appropriate cost of capital to be used to discount average risk projects is _________.
the expected return on the market portfolio
When considering mutually exclusive projects, the project that adds most to shareholder wealth is the one with:
the highest NPV
The payback period for a project can best be defined as:
the length of time before you recover your initial investment
The market value of a firm is equal to:
the market value of debt + the market value of equity
The discount rate used to value capital investments is often referred to as ____.
the opportunity cost of capital
An opportunity cost arises in a project whenever:
the project uses an existing asset that could have been sold or put to productive use elsewhere
Select all that apply U.S. Treasury bills are nearly a risk-free investment because:
they have short-term maturities they are issued by the U.S. government
Select all that apply Some of the reasons that managers may bias their project cash flow forecasts upward are:
to gain approval of their division's projects at the expense of other divisions' projects they are too optimistic about their project's chances of success to gain approval of projects that will grow their responsibilities and power
Cash flows from capital investments + operating cash flows + cash flows from changes in working capital =
total cash flow
A beta of 0 indicates that a security is _________ by what happens in the market.
unaffected
Debt that is repayable less than one year from the date of issue is called _______ debt, or _______ debt.
unfunded; short-term
A major limitation of using standard deviation of historical stock returns to predict future investment risk is ________.
variability of returns does not remain constant from year to year
Variance and standard deviation are measures of __________
volatility
Variance and standard deviation are measures of __________.
volatility
The timing real option is really an option to _________.
wait until the firm has additional information about project success before investing
The right to buy shares from a company at a stipulated price before a set date is called a ___________.
warrant
The right to buy shares from a company at a stipulated price before a set date is called a:
warrant
The CAPM assumes that the stock market is composed of _______ investors.
well-diversified
When calculating NPV, the proper time to record investment expenditures is:
when they occur
A firm's capital budget is generally drawn up on a _____ basis.
yearly