CHAPTER 10 CORP FIN

A project's NPV without flotation costs is $1,000,000 and its flotation costs are $50,000. What is the true NPV?

$1,000,000 - 50,000 = $950,000

Calculate the cost of capital for an all-equity firm with equity of $12,500 and expected earnings of $1,900.

$1,900/$12,500 = 15.2%

Firm B uses no debt. If the tax rate on corporate income is 30% and the personal tax rate on interest income and dividend income is 15%, what is the net cash flow to firm B's shareholders if pretax earnings are $100?

$100 × (1 - 0.30) × (1 - 0.15) = $59.50

A company recently paid a dividend of $2 per share. You estimate dividend growth to be 6%. What do you expect next years dividend to be?

$2.12

If the flotation costs are 2% of gross proceeds, and gross proceeds are $250,000, what is the dollar amount of flotation costs?

$5,000

Solid Rock is an unlevered firm with an EBIT of $10 million and an unlevered cost of capital of 12 percent. If the tax rate is 40 percent, what is the value of the firm?

$50 million

The initial investment for a project is $400,000, of which 35% will be financed with debt. The project would generate $72,000 in cash flow for equity holders if the firm were unlevered. If the interest rate on the debt is 8% and the tax rate is 24%, what is the cash flow to the equity holders given that the firm is leveraged?

$63,488

A project's NPV without flotation costs is $750,000 and its flotation costs are $25,000. What is the true NPV?

$725,000

The initial investment for a project is $500,000, of which 40% will be financed with debt. The project would generate $89,000 in cash flow for equity holders if the firm were unlevered. If the interest rate on the debt is 8% and the tax rate is 40%, what is the cash flow to the equity holders given that the firm is leveraged?

$89,000 - (1−0.4) × 0.08 ×(0.4×$500,000) = $79,400

A firm needs to sell enough equity to raise $950,000 after covering the flotation costs of 5 percent. How much will it pay in flotation costs?

$950,000 = Amount Raised × (1 - .05) Amount Raised = $1,000,000 Flotation Costs = $1,000,000 - 950,000 = $50,000

If a firm has $10 million of debt with a debt beta of .4 and $30 million of equity with equity beta of 2, then the firm's asset beta is ____.

($10/$40)(.4) + ($30/$40)(2) = 1.6

A company with $4 million in debt and $10 million in equity has a cost of debt of 7 percent, a cost of equity of 12.18 percent, and a tax rate of 35 percent. What is the firm's WACC?

($10m/$14m)(.1218) + ($4m/$14m)(.07)(1 - .35) = .10, or 10%

What are the after-tax earnings for HIJ Corporation if it reports $200 in revenue, $90 in operating expenses, has a tax rate of 30%, and pays $20 in interest on its bonds (assume all interest is tax deductible).

($200 - $90 - $20) × (1 -0.3) = $63

You buy a stock for $50. After one year, its price rises to $55, and it pays a $2 dividend.. You do not sell the stock. Your capital gains yield is _____.

($55 - 50)/$50 = 10%

If ABC Co. has earnings before interest and taxes of $2 million with debt of $5 million, what is the total cash flow to bondholders and stockholders if the interest rate is 10 percent and the tax rate is 35 percent?

(.1 × $5m) + [$2m - (.1 × $5m)](1 - .35) = $1,475,000

A firm's capital structure consists of 30 percent debt and 70 percent equity. Its bonds yield 10 percent, pretax, its cost of equity is 16 percent, and the tax rate is 40 percent. What is its WACC?

(0.7 × .16) + (0.3 × .1 × (1 - 0.4)) = .13 or 13%

If the risk-free rate is 3 percent, the market risk premium is 7 percent, the industry beta is 1, and the firm beta is 2, the cost of equity will be ____ percent less if the industry beta is used instead of the firm beta.

(1 - 2) × 7% = 7%

A firm's cost of debt can be

*obtained by checking yields on publicly traded bonds *estimated easier than its cost of equity *obtained by talking to investment bankers

In bank mergers, the stock of the target bank usually changes by about ______ percent upon the first announcement of the merger, and the stock of the acquiring bank changes by about ______ percent.

+23; -5

Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBI)?

- Financial leverage increases the slope of the EPS line - Below the indifference or break even point in EBIT, an unlevered capital structure is best - The rate of return on assets is unaffected by leverage

Which of the following are true?

- Ideally, we should use market values in the WACC - Book values are often similar to market values for debt.

To estimate a firm's equity cost of capital using the CAPM, we need to know the ___.

- Stock's beta - Market risk premium - Risk-free rate

Which of the following variables do we need to compute the beta for a company's stock?

- the variance of the market index's returns - the covariance between the stock and the market index's returns

The diversification benefits from holding two securities in a portfolio are maximized when the correlation between the securities is ____.

-1

Which of the following involves a firm distributing stock instead of cash to its owners?

-A stock dividend -A stock split

Which of the following is true about stock dividends ands stock splits?

-Both will reduce the share price -Both will increase the total number of shares

What is the standard deviation (SD) of a portfolio that is invested 40 percent in a risky asset and 60 percent in a risk-free asset if the SD of the risky asset is 15 percent?

.4 × 15% = 6% SD of risk-free asset = 0

What is the beta for stock A if the covariance between stock A and the market is 1.5 and the variance of the market is 2.5?

.6 1.5/2.5 = .6

Empirical evidence indicates stock return serial correlation coefficients are near:

0

If a firm is in financial distress and generates a $30 cash flow, what will be the total payment made to shareholders if the only remaining claimant on the firm's assets are the bondholders with a total claim of $40?

0

If a stock's returns are uncorrelated with inflation, what is its inflation beta?

0

What is the beta of a riskless security?

0

You own 300 shares of Omega Co. with a value of $10 per share. As a result of a 2-for-1 stock split, you now own 600 shares and your wealth has increased by ___.

0

What is the return on a portfolio with 30% of its assets invested in the risk-free security and 70% of its assets invested in asset A if the return on the risk-free security is 4% and the return on asset A is 12%?

0.3 × 4% + 0.7 × 12% = 9.6%

Omega Corp. has $20 million in perpetual debt outstanding with a coupon rate of 8 percent. The tax rate is 40 percent. What is the tax shield from debt?

0.40 × $20m × 0.08 = $0.64m

What is the beta of a portfolio that is invested 50% in riskless security, 30% in risky asset A, and 20% in risky asset B? Asset A has a beta of 1 and Asset B has a beta of 2.

0.5 × 0 + 0.3 × 1 + 0.2 × 2 = 0.7

What is the return on a portfolio with 50% of its assets invested in risk-free security and 50% of its assets invested in asset A if the return on the risk-free security is 2% and the return on asset A is 8%?

0.5 × 2% + 0.5 × 8% = 5%

If a security's expected return is equal to the expected return on the market, its beta must be ____.

1 If a security's expected return is equal to the expected return on the market, its beta must be 1, because the expected return is equal to the risk-free rate + beta X the risk premium on the market.

The weighted average cost of capital (WACC) formula, for a firm with no debt or preferred stock will have a WACC of:

1 × Cost of equity

If the firm issued so much debt that its equity was valueless, its average cost of capital would equal ___.

1 × the aftertax cost of debt or its cost of debt

Place the steps needed to calculate the value of a levered firm with perpetual cash flows in order starting with the first step.

1. Calculate EBIT 2. Multiply EBIT by 1 minus the corporate tax rate 3. Divide by the cost of equity for an all-equity firm 4. Add the present value of the debt tax shield

You have estimated the following model for stock return based on three factors: Actual Return = Expected Return + βinterestFinterest+βinflationFinflation+βGNPFGNP + ε You are further told that βinterest=1.5; βinflation=-1.8; βGNP=1.1; Finterest=2%; Finflation=-2%; FGNP=1.5%. What is total effect of systematic risks on the stock return?

1.5 × 2% + -1.8 × -2% + 1.1 × 1.5% = 8.25% 8.25%

If a firm has $15 million of debt with a debt beta of 0.2 and $40 million of equity with equity beta of 2.2, then the firm's asset beta is ____.

1.65

According to the Wall Street Journal, the average dividend yield for the stocks that comprise the S&P 500 Index was approximately

1.8%

If a company can issue 4% tax-exempt industrial bonds as opposed to regular 10% bonds, the savings per period should be discounted at ______%.

10% 10% is the opportunity cost.

If a company can issue state industrial bonds for 4% versus the normal 10%, then it can save ______% on its coupon rate.

10% - 4% = 6%

If there are 9 directors to be elected, what is the least number of shares you will need to guarantee a seat on the board under cumulative voting?

10% of the stock plus one share

With a "one share, one vote" rule, you will be entitled to ______ votes if you are holding 100 shares in a corporation.

100

Which of the following are some of the bad reasons firms give for leasing instead of buying?

100% financing Off-balance sheet financing

The most popular dollar value for the par value of a corporate bond is ______.

1000

A firm has $5,000 of debt, $16,000 of equity, a cost of debt of 8 percent, and a cost of equity of 12 percent. What is the firm's WACC if there are no taxes?

11.05% = ($16,000/$21,000) x 12% + ($5,000/$21,000) x 8%

King's unlevered cost of equity is 11 percent and its pretax cost of debt is 8 percent. The firm has a debt-equity ratio of .4. If the tax rate is 40 percent, what is King's cost of equity?

11.72%; 11% + .4 x (1-.4) x (11% - 8) = 11.72%

Alpha Co. has a debt-equity ratio of .6, a pretax cost of debt of 7.5 percent, and an unlevered cost of equity of 12 percent. What is Alpha's cost of equity if you ignore taxes?

12% + .6(12% - 7.5) = 14.7%

An industry has three firms with unlevered betas of 0.9, 1, and 1.4. What is the discount rate to use for an unlevered firm that wants to enter this industry if the risk-free rate is 5% and the expected return on the market is 12%?

12.7% Reason: β = (0.9 + 1 + 1.4)/3 = 1.1 r = 5% + 1.1(12% - 5%) = 12.7%

You buy a stock for $100. In one year its price rises to $114, and it pays a $1 dividend. Your capital gains yield is:

14%($114-100)/$100

According to the security market line (SML), what is the cost of equity capital for a company if the risk-free rate is 2%, the market risk premium is 9%, and beta is 1.5?

15.5%

Calculate the cost of capital for an all-equity firm with equity of $225,000 and expected earnings of $35,000.

15.6%

Skywalker Corporation wishes to be levered at a debt to value ratio of 0.45. Their cost of debt is 6.5% and their tax rate is 24%. What is the cost of equity (RS) for BX if their cost of equity as an all equity firm (R0) is 13%?

17%

An industry has three firms with unlevered betas of 0.7, 1.1, and 1.6. What is the discount rate to use for an unlevered firm that wants to enter this industry if the risk-free rate is 3% and the expected return on the market is 17%?

18.9%

According to bankruptcy laws the corporation is given ____ days from the filing date to gain acceptance of a bankruptcy plan.

180 days

Rp=XA (RA+βAF+ εA) + XB(RB+βBF+εB) represents the return of a ______-asset portfolio.

2

The probability of a return being more than two standard deviations below the mean in a normal distribution is approximately ___ percent.

2.5

Long-term corporate bonds is a portfolio of high-quality corporate bonds with ___-year maturities.

20

ABC Corporation has 20,000 shares outstanding at $40 each. It wants to raise $150,000 by a rights offering with a $30 subscription price. How many rights are required to purchase one new share?

20,000/($150,000/$30) = 4 rights 4

British Xeon Corporation (BX) wishes to be levered at a debt to value ratio of 0.6. Their cost of debt is 8% and their tax rate is 40%. What is the cost of equity (RS) for BX if their cost of equity as an all equity firm (R0) is 15%?

21.3% 15% + 0.60.4(1 - 0.4)(15% - 8%) = 21.3%

XYZ Corporation has 15,000 shares outstanding at $50 each. It wants to raise $200,000 by a rights offering with a $40 subscription price. How many rights are required to purchase one new share?

3

Previously, a firm issued bonds at par with a 3% coupon. Today, similar bond yields are 6% and the risk-free rate is 2%. What is the embedded cost of the firm's debt?

3%

The 95.4 percent confidence interval for the historical standard error for the true U.S. equity risk premium should be within ___ percent to ___ percent.

3.4; 11

What is Stock B's beta if the covariance between stock B and the market is 3.75, and variance of the market is 2.5?

3.75/2.5 = 1.5

If a stock is currently selling at $150 per share and a five-for-one split is announced, the new price per share should be about:

30

What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?

4% + 1.2(12% - 4%) = 13.6%

If the risk-free rate is 4 percent, an all-equity firm's beta is 2, and the market risk premium is 6 percent, what is the firm's cost of capital?

4% + 2 × 6% = 16%

If a company has a cost of debt of 6% and a corporate tax rate equal to 22%, what is the after tax cost of debt?

4.68%

If a firm has a capital structure of 40% debt and 60% equity and the after-tax cost of debt is 10% and the cost of equity is 18%, what is the WACC?

40% × 10% + 60% × 18% = 14.8%

A $1,000 par value bond that was purchased for $1,100 has a coupon rate of 5%. What is the annual interest income?

50

If you hold 50 shares of a particular corporation's common stock and there are 5 directors to be elected, how many votes will you be allowed to cast under cumulative voting?

50 shares × 5 positions = 250 votes

In 2012, the ratio of dividends to earnings in the US was about:

50%

The average stock has a standard deviation of about

50%

What is the approximate standard deviation of the returns on an average stock?

50%

If there are 9 directors that need to be elected, how many shares do you need to own in order to guarantee a seat on the board under straight voting?

50% of the stock + 1 share

Suppose a firm faces a risk-free rate of 2%, a beta of 1, and a market risk premium of 4%. What is its cost of capital if it is an all-equity firm?

6% 2% + 1 × 4% = 6%

If an investor buys $20,000 worth of stock by investing $11,000 of their own money, how much was borrowed?

9000

If a company has a cost of debt of 8% and a corporate tax rate equal to 35%, what is the after tax cost of debt?

= 8(1-0.35) 5.2%

Which of the following are types of divestitures?

A carve-out A spin-off The sale of a business unit

Which of the following is true?

A company can deduct interest paid on debt up to 30% of EBIT when computing taxable income.

Which of the following is not an example of friendly takeover?

A direct offer from the bidding firm to the target firm's shareholders

Which of the following are not characteristics of a financial lease?

A financial lease is not fully amortized.

Which of the following are true about "Greenmail"?

A firm buys back its stock from a potential bidder The profits from greenmail are taxable

Given agency conflicts between shareholders and bondholders, which type of firm is likely to experience distortions in investment policy?

A levered firm

Who is more likely to indulge in wasteful behavior?

A manager with a small ownership interest in the firm

What does horizontal acquisition involve?

A merger between firms in the same industry

Which statement is true concerning a reorganized firm's stock price?

A private workout leads to greater stock price increases than formal bankruptcy.

Which firm has a higher debt capacity?

A profitable firm

What does the backward bending portion of the feasibility set indicate?

A reduction in portfolio risk due to diversification benefits.

Which form of bond identifies the unique owner of the bond in the issuing company's records?

A registered bond

Which of these actions do many managers take when they consider the firm's stock to be undervalued?

A stock repurchase

A model that includes a market portfolio factor and a GDP factor is which of the following:

APT

Which of the following can handle multiple factors?

APT

The ______ approach to capital budgeting should be used if the project's level of debt is known over the life of the project.

APV

When there are side benefits and side costs to debt, the preferred capital budgeting technique is

APV

Which approach to capital budgeting should be used in a lease-versus-buy decision?

APV

Which of the following are ways in which a firm can be acquired?

Acquisition of assets Merger Acquisition of stock

Which of the following equations represents the return on any stock?

Actual return = Expected return + Unexpected return

Place the following claims in the order they should be paid based on the priority of the claims.

Administration Costs wages taxes preferred stock holders

Which of the following is paid first according to the priority of claims?

Administration expenses

What is the primary source of dividends?

After-tax profits

What does a normal return depend upon?

All relevant information available to shareholders

Omega Corporation is proposing a reorganization based on a going-concern value of $3,000,000. The new structure will have $1,000,000 in new mortgage debt, $150,000 in subordinated debt and $2,000,000 in new equity. All creditors, both secured and unsecured, are owed $5,000,000 dollars. There is a mortgage lien for $2,000,000 on the company's buildings. The corporate tax rate is 34%. How much should the unsecured creditors receive?

Amount unsecured creditors will receive=$3,000,000-$2,000,000=$1,000,000

What is expropriation in the context of agency costs of the firm?

An improper transfer of wealth from bondholders to shareholders

Which of the following are examples of signaling by a firm?

An increase in the target debt ratio An increase in dividends

If the monthly return is 0.0063 what is the annual return?

Annual return = (1.0063)^12 - 1 = 7.83%

If the monthly return is 0.0078 what is the annual return?

Annual return = (1.0078)^12 -1 = 9.77%

What is signaling?

Any announcement or action by the firm that conveys information to the market.

______ is the process of buying of underpriced securities while selling overpriced substitutes.

Arbitrage

From a tax shield perspective, what is the expected relationship between a firm's profitability and its level of debt?

As profitability increases, a firm will increase the level of debt.

____ exists when a firm's manager knows more about the firm's prospects than the typical investor does.

Asymmetric information

When is the present value of distress costs likely to exceed the present value of the tax shield from debt?

At high levels of debt Financial distress costs lower the value of the levered firm.

What are some ways in which a bankruptcy filing might hinder a firm's normal business operations?

Banks may place restrictions on the firm's financial activities. Suppliers may not supply inventory, fearing nonpayment. Customers may not buy, fearing future service problems.

How can a positive relationship between expected return on a security and its beta be justified?

Because the difference between the return on the market and the risk-free rate is likely to be positive.

For a diversified investor, what is the best way to measure the systematic risk of an individual security?

Beta

What is the relevant measure of risk in a large well diversified portfolio?

Beta (β)

What do we know about the stability of a firm's beta?

Betas are more likely to be stable if the firm remains in the same industry. Betas can change over time.

The _____discount model requires estimation of the dividend yield and_____rate.

Blank 1: dividend Blank 2: growth

Changes in ______leverage and ______leverage will affect beta.

Blank 1: financial Blank 2: operating

Who does the trustee represent?

Bondholders

What are the differences in the claims of shareholders and bondholders during bankruptcy?

Bondholders have a fixed claim while shareholders have a variable claim on all the residuals. Bondholders claims are settled first.

Assume firm A is all equity and firm B is all debt. If the tax rate on corporate income is 35%, what is the distribution to shareholders in firm A and bondholders in firm B if both firms earn pre-tax income of $100?

Bondholders receive $100 while shareholders receive $65.

Flotation costs are costs incurred to ____.

Bring new security issues to the market

Which of the following companies might have an inflation beta of zero?

Brokers who buy items in competitive markets and resell them in other markets.

Which of the following could be mortgaged?

Building Land Equipment

How can a firm create value in its capital budgeting process?

By being ahead of other companies in developing new products By producing its products and services at lower costs

How are most votes cast at the annual meetings of large public corporations?

By proxy

For both academics and practitioners, the pendulum has swung over to the _______ for estimating the cost of equity capital.

CAPM

The_____can be used to estimate the required return on equity.

CAPM

If on days -1, 0, and +1 the abnormal returns are 1, 2, and 3 percent, respectively, then the cumulative abnormal return on day +1 is ___ percent.

CARDay +1 = 1% + 2 + 3 = 6%

What type of bonds can be redeemed before the maturity date by the issuing corporation?

Callable bonds

Which of the following can cause a firm's beta to change over time?

Changes in technology Changes in leverage Changes in product line

________ occurs once the acquiring firm gets control of the target and proposes a merger to obtain the remaining shares it does not already own.

Cleanup

Which of the following institution(s) is/are the significant participant in the term loan market?

Commercial banks

Which of the following are examples of collateral?

Common stock Building Equipment

Who enjoys the right to elect the board of directors in a corporation?

Common stockholders

Which of the following are fixed for a conventional bond?

Coupon payments The principal

In what ways can a firm create value with its capital budgeting decisions?

Create a barrier to competition Locate an unsatisfied demand

Which of the following are reasons why corporate treasurers prefer the use of book values when measuring debt ratios?

Credit rating firms use book values. Bond covenant restrictions are based on book values. Stock markets are very volatile

Which of the following are reasons for violations of the absolute priority rule?

Creditors seek to avoid litigation Managers who own equity want to be compensated A bankruptcy judge pressures the parties to compromise

What two types of voting methods are used to elect directors to a corporation's board?

Cumulative voting Straight voting

Which two groups usually compete to obtain votes from shareholders during a proxy fight?

Current management and an outside group of shareholders

Debentures commonly pledge which type of property as security?

Debentures do not pledge specific properties

If there are no personal taxes or financial distress costs, will a firm prefer to issue debt or equity?

Debt

Which has priority when applying APR?

Debt claims

What are the two main types of securities issued by a corporation?

Debt securities Equity securities

What type of risk does a bond rating attempt to measure?

Default risk

Which of the following would be positive behavioral changes due to financial distress?

Disposing of unrelated businesses Changing to a new operating strategy Developing a new organizational form

Which of the following are ways in which diversification can produce gains to the acquiring firm:

Diversification reduces risk and thereby increases debt capacity

Dividends received by shareholders are expressed in which of the following ways?

Dividend payout Dividends per share Dividend yield

Which of the following are advantages to paying dividends?

Dividends appeal to shareholders when transaction costs are high. Dividends can fulfill the current consumption needs of investors with limited self-control. Dividends can signal managers' optimism concerning future cash flows.

Which of the following are drawbacks to paying dividends?

Dividends are hard to cut (stickyness) without adversely affecting stock price Dividends can reduce internal sources of financing.

What are some differences in the income received by common stockholders and the income received by bondholders?

Dividends are not fixed, but interest is generally a fixed dollar amount. Common stock pays dividends while bonds pay interest. Dividends are not based on the par value of stock, but interest is generally based on a bond's par value.

Which of the following are true about dividends?

Dividends may not be paid every year. Dividends represent return on capital for current shareholders.

What can we say about the dividends paid to common and preferred stockholders?

Dividends to common stockholders are not fixed. Dividends to preferred stockholders are fixed.

In a rights offering, when an existing stockholder is notified that they have been given one right for each share of stock owned, they can do which of the following?

Do nothing and let the rights expire Order all the rights to be sold Subscribe to the full number of entitled shares

With the ______ method of issuing securities, the offering price is determined by submitted bids.

Dutch auction

When two banks merge into one mega bank, what could be some sources of benefit from the merger?

Economies of scale Complimentary resources

______ studies examine whether or not the release of information on one day influences stock returns on other days.

Event

Which of the following is not an explanation for why new equity issues in the United States are usually sold without rights.

Exercising rights is too convenient for stockholders

What is the equation for the capital asset pricing model?

Expected return on a security = Risk-free rate+ beta x expected risk premium on market

With the trade-off theory, one must consider which of the following?

Expected tax benefits from leverage Expected distress costs

True or false: The APV and WACC do not reflect the tax benefit of debt.

FALSE

Which of the following represent equally valid accounting choices?

FIFO Straight-line or accelerated depreciation

The ______ approach to capital budgeting discounts the after-tax cash flow from a project going to the equity holders of a levered firm.

FTE

Which of the following approaches to capital budgeting should be used if the firm's target debt-value ratio applies over the life of the project.

FTE WACC

The par value of a bond is almost always higher than the face value.

False

True or false: A cleanup merger refers to a case in which an acquiring company makes more than 25% profit on the purchase of the target company.

False

True or false: Accepted accounting procedures do not provide any reporting flexibility to users.

False

True or false: Common stockholders receive special preference in receiving dividends.

False

True or false: Dividend policy is relevant.

False

True or false: If you take more risk and earn a higher return, then the market is not efficient.

False

True or false: In a rights offering, existing shareholders must purchase more shares.

False

True or false: Plain vanilla bonds are exotic bonds with unique features.

False

True or false: Projects should always be discounted at the firm's overall cost of capital.

False

True or false: Risk aversion means that investors will not take risks.

False

True or false: Systematic risk will impact all securities in every portfolio equally.

False

True or false: The average return on the stock market can be used to find ways to beat the market.

False

True or false: The legacy effect arises because young, fast growing firms pay many dividends.

False

True or false: There is a precise mathematical equation that can be used to find the optimal debt-equity ratio for every firm.

False

True or false: Throwing darts at the financial pages to construct a portfolio is not be a good strategy because professional security analysts always outperform dart portfolios.

False

A registration statement contains which of the following?

Financial history Existing business details Future plans Proposed financing

Which of the following does the efficient markets hypothesis tell us?

Financial managers cannot time bond and stock sales. Prices correctly reflect value.

Firm A has bought a significant number of Firm B's shares. Firm B wants to avoid a takeover by Firm A, so it does an exclusionary self-tender offer. It will exclude purchases of the stock owned by:

Firm A

Which of the following are true in a prepackaged bankruptcy?

Firm's will find it difficult to use when there are many reluctant creditors Creditors agree to a private workout The firm must reach agreement with most of the creditors privately

How does managerial ownership of equity affect the debt-equity ratio of real world companies?

Firms in which managers have high equity ownership tend to have lower leverage.

This approach to capital budgeting calls for discounting the cash flow from the project to the equity holders of the levered firm at the cost of equity capital.

Flow to Equity (FTE)

What is the likely impact on the work ethic of an employee once he acquires shares in the firm where he works?

He is likely to work harder.

Historically, how have mergers affected the bidder's stockholders?

Historically mergers have hurt the bidder's stockholders in dollar terms

______dividends allows stockholders to choose the dividend payout they want

Homemade

Which of the following industries have high leverage ratios?

Hotel/gaming Building construction

______ will offer an opinion on whether or not a lessee can deduct lease payments for income tax purposes.

IRS

In the ____________and _____________study the large-company common stock portfolio is based on the Standard & Poor's Composite Index.

Ibbotson Sinquefield

Which of the following are true about the stock performance of other countries in 2008?

Iceland's stock prices fell by more than 90%. India's stock prices only fell by more than 50%.

If a firm increases its level of debt, its beta will ___.

If a firm increases its level of debt, its beta will also increase, because some of the firm's cash flows will belong to debt holders, which increases risk to equity also increase

Under what conditions may a preferred stockholder be given the right to vote?

If preferred dividends have not been paid for a long time

Under which of the following scenarios is the inflation beta likely to be zero?

If the costs and revenues rise and fall together.

Which of the following are true if AIG's beta is -4.53?

If the market declines 1%, AIG should rise by about 4.53%. If the market rises 1%, AIG is should decline by about 4.53%.

What are some opportunities for marketing gains in a merger?

Improved distribution networks Improved product mix

How does a consolidation differ from a merger?

In a merger the acquiring firm retains its identity; in a consolidation both firms terminate their previous legal existence.

In what ways are spin-offs and carve-outs similar?

In both cases, it is easier to value the firm after the divestiture In both cases, a separate entity is created with new shares In both cases, the parent company becomes more focused after the divestiture

How is beta interpreted in the CAPM and the APT?

In the APT, beta measures the responsiveness of a security's return to a particular factor. In the CAPM, beta represents the responsiveness of a security to the movements in the market portfolio.

When is the seniority of debt of particular importance?

In the event of default by the corporation

Sam owns 2 percent of the firm he manages. What things might Sam be tempted to do that would benefit himself but increase his firm's agency costs?

Increase his leisure time Increase his work-related perquisites Take on unprofitable projects

Which two of the following are broad types of costs of financial distress?

Indirect costs Direct costs

Which of the following assumptions is necessary for MM Proposition I to hold?

Individuals can borrow on their own at an interest rate equal to that of the firm.

Why do profitable firms tend to have more debt?

Interest expense generates tax savings.

The benefits of formal bankruptcy include which of the following?

Interest on prebankruptcy unsecured debt stops accruing The carryover of tax benefits The ability to issue new senior debt

Which of the following assets do not qualify as real property?

Inventories Cash

In a perfect market, which of the following is true?

Investors are indifferent between a stock repurchase and a cash dividend.

Which of the following are reasons why investors might favor a high dividend payout?

Investors have a preference for current income. Stock sales are time consuming. The transactions costs for selling low dividend paying stocks can be avoided.

Which of the following are ways a firm can reduce its costs or increase its subsidies in the area of financing?

Issue securities with tax breaks. Issue securities with reduced investment banking fees.

What is the distinguishing feature of convertible preferred stock?

It can be converted into common stock.

What is one important advantage of APT over CAPM?

It can handle multiple factors.

What can we conclude about a corporate bond that is rated AAA?

It has a very low risk of default.

Which of the following is (are) true about CAPM?

It implies that expected return will increase as beta increases. It models the expected return on a security.

What is the impact on the present value of distress costs as more debt is added?

It increases

What are some of the reasons for divestiture through the sale of corporate assets?

It is a defense against hostile takeover. It is easier to value firms after the sale. It provides cash for liquidity-poor firms.

A financial lease has which of the following characteristics?

It is a fully amortized lease. The lessee maintains the leased equipment.

What is a sinking fund?

It is a fund set up for the repayment of bonds.

What is unsystematic risk?

It is a risk that affects a single asset or a small group of assets.

What is systematic risk?

It is a risk that pertains to a large number of assets.

If a security's expected return is equal to the risk-free rate of return, and the market-risk premium is greater than zero, what can you conclude about the value of the security's beta based on CAPM?

It is equal to 0. E(Ri) = Rf +βi(RM - Rf) = Rf → βi= 0

How is the annual coupon income calculated for a traditional bond?

It is equal to the coupon rate multiplied by par value.

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

It is likely to decrease. It may eventually be almost totally eliminated.

What happens to unsystematic risk in a large portfolio?

It is reduced to zero or close to zero.

What is the maturity of a debt instrument?

It is the length of time the debt remains outstanding with some unpaid balance.

What is a protective covenant?

It is the part of the bond indenture that protects bondholders by limiting the actions of the corporation.

Which of the following are true regarding the face value of a bond?

It is the value stated on a bond certificate. It is the principal value of the bond.

Which of the following are true for the absolute priority rule of bankruptcy?

It makes sure senior claims are paid first. It sets the priorities for liquidation. It spells out the priorities for the distribution of proceeds.

What are the two basic effects of staggering elections?

It makes takeover attempts more difficult. It makes it harder for minority shareholders to elect a board member under cumulative voting.

What are the advantages of using internal financing?

It may be cheaper than debt or equity issues. It prevents the adverse market reaction that tends to accompany a stock issue.

In which of the following ways could a golden parachute impact a takeover attempt?

It may increase the likelihood of a takeover because management will not worry about their jobs in the new company. It does not always deter a takeover because it probably is a small part of the takeover cost. It raises the cost of a takeover attempt.

What does it mean if βi is equal to zero?

It means that actual return = expected return + εi It means the ith stock's returns are not affected by the factor, F.

What does it mean if the returns of two stocks, A and B, are negatively correlated?

It means that, on average, if the returns of stock A are positive, the returns of stock B will be negative.

Which of the following are true based on the given equation?

It models the expected return on a security (or a portfolio) based on multiple factors The equation is a multifactor version of the APT.

What is the benefit of cumulative voting procedures?

It permits minority participation.

What is the most important benefit of debt?

It provides a tax benefit.

According to the free cash flow hypothesis, how does the distribution of dividends benefit shareholders?

It reduces the amount of free cash flow available to managers for making bad acquisitions.

What are the benefits of having fewer lenders during bankruptcy?

It reduces the conflicts among lenders. It makes it easier for the firm to negotiate with lenders.

What does the characteristic line for a security show?

It shows a security's return in relation to the market's return.

Which of the following is true about the third part of the equation (1/N)ε1 + ⋅⋅⋅ + (1/N)εN?

It will disappear or get close to zero as we increase the size of the portfolio. It captures the unsystematic risk of individual securities in the portfolio.

What is the impact of fraud on security prices?

It will distort prices in the short-run. Security prices will likely revert to equilibrium once the fraud is discovered

What is the impact of the distribution of cash dividends on a corporation's financial statements?

It will reduce the cash balance. It will reduce owner's equity. It will reduce the balance of retained earnings.

If a firm issues no debt, its average cost of capital will equal ___.

Its cost of equity

Jackie, a sole proprietor, needs to raise $200,000 to expand her operations. Under which of the following financing arrangements is she likely to obtain more perquisites such as a lavish expense account?

Jackie brings in an additional partner and reduces her ownership share.

Most of the difference in small and large stock returns occurs in the month of ____.

January

Which of the following are examples of unsystematic risk?

Labor strikes Changes in management

Which of the following is true about the IPO market?

Large initial gains in stock prices often occur.

What is generally the most important component of direct costs of financial distress?

Legal costs

If a corporation has 10 seats on the board of directors, how many directors will be elected each year with a staggered election?

Less than 10 board members

Which of the following tactics are used by the target firm to reduce the appeal of takeover?

Leveraged recapitalization Using cash to repurchase shares Using cash to pay a dividend

The synergy after a merger that results from increased cash flows comes from which of the following sources?

Lower capital requirements Cost reductions Revenue enhancement

Why is MM's assertion about the positive relationship between firm value and leverage not observed in the real world?

MM did not consider bankruptcy costs.

Which of the following are examples of fixed capital?

Machinery Building

Which one of the following is true about marketable claims?

Marketable claims can be bought and sold in financial markets.

Firm Pancakes was worth $500 and Firm Waffles had a value of $400. Firm Pancakes acquired Firm Waffles because they thought the combination of the new Firm Panaffles was worth $1,000. What was the NPV of the merger?

NPV = $1,000 -($500 + $400) = $100

ABC Onions was worth $450 and CBA Onions had a market value of $375. ABC acquired CBA for $425 because they thought the new combined firm was worth $925. What is the NPV of the merger of ABC and CBA?

NPV = $925 - ($450 + $425) = $50

Given agency conflicts, why would shareholders tend to underinvest during times of financial distress?

New investment benefits the bondholders at the shareholder's expense

Equity holders would expect what payout according to APR?

No payout

Which of the following have been identified by behavioral finance researchers as examples of irrationality?

Not diversifying enough Not minimizing taxes Gambling

Which of the following is not normally a function of an investment bank?

Offering corporate checking accounts

When is a new issue usually priced?

On the last day of the registration period

In general, how frequently is the board of directors elected?

Once a year

When an individual stock is part of a well diversified portfolio, what type of risk matters?

Only the systematic risk of the individual stock

What types of information affect the rates at which stock prices adjust to new information?

Past information All information Publicly available information

What are the two areas where preferred stockholders have greater rights relative to common stockholders?

Payment of dividends Distribution of assets in the event of liquidation

Which of the following institutions dominate the private placement segment of the bond market?

Pension funds Life insurance companies

Financial distress is manifested in which of the following ways?

Plant closings Plummeting stock prices Layoffs

Portfolios A and B have an expected return of 10%. Portfolio A has a standard deviation of 6% while Portfolio B has a standard deviation of 13%. Which portfolio would a rational investor choose?

Portfolio A

If security ABC has a beta of 1.5 and security XYZ has a beta of 1, what is the beta of a portfolio that is equally invested in both securities?

Portfolio beta = 0.5 × 1.5 + 0.5 × 1 = 1.25 1.25

Which group of shareholders, common or preferred, is considered senior at the time of distribution of assets during liquidation?

Preferred stockholders

Historically, almost half of all financial restructuring is done through:

Private workouts

Which of the following is not true concerning private workouts of financial distress?

Private workouts account for 75% of all reorganizations.

Which of the following are reasons private workouts are beneficial?

Private workouts are less costly than formal bankruptcy. Firms that emerge from private workouts experience a higher stock price increase than firms emerging from bankruptcy.

_______ voting occurs when a shareholder gives someone else the authority to vote on her behalf.

Proxy

The mathematical representation of weak form efficiency is:

Pt = Pt - 1 + Expected return + Random errort

A market is said to be semistrong efficient if prices incorporate which type of information?

Publicly available information

A firm with excess free cash flow might consider which of the following alternatives to paying dividends?

Purchasing financial assets Acquiring other companies Repurchasing shares

The formula for the dividend discount model when the growth rate is zero is ___.

R = Div/P

The formula for calculating the cost of equity capital that is based on the dividend discount model is ___.

R = Div/P + g

what is the CAPM formula?

RS = RF + β× (RM- RF)

Which of the following conditions will cause market efficiency according to Andrei Shleifer?

Rationality Independent deviations from rationality Arbitrage

Which of the following guidelines reflect the IRS's view of a deductible lease?

Reasonable renewal options The lease buy out reflects market value. A term less than 30 years

Which of the following are ways to create valuable financing opportunities?

Reduce costs or increase subsidies Create a new type of security

______ bonds are the most common type of bond in the United States today.

Registered

According to the pecking order theory, what is the preferred source for firms seeking to raise capital?

Retained earnings

What is the preferred source of financing for firms according to the pecking-order theory?

Retained earnings

Which of the following is a documented anomaly?

Royal Dutch and Shell shares not trading at parity

A portfolio return is a weighted average of the returns of the individual assets in the portfolio. If we use Ri to indicate the Return on asset i and Xi to indicate the weight of asset i, we can express the portfolio return (Rp) for a portfolio with N assets as:

Rp = X1R1 + X2R2 + ... XNRN

How can the return of a 2-asset portfolio (Rp) consisting of stocks A and B be expressed if the stocks are weighted XA and XB respectively and a single factor model is used to find the stocks' returns?

Rp=XA (RA+βAF+ εA) + XB(RB+βBF+εB)

Suppose a firm has a target debt-equity ratio of 2.5. What is the firm's target capital structure weight for common stock?

S/(S + B) = 1/3.5 = 28.57%

Which of the following are NOT assumptions of market efficiency?

SEC oversight

Who has the first claim on assets after liquidation?

Secured creditors

How can arbitrage trade be implemented using security B and security P?

Sell short security B and buy security P

Which of the following is/are exit strategies that a venture capitalist might want to use?

Selling an investment to another company Taking an investment public

_______ indicates preference in position over other lenders.

Seniority

Which of the following are sensible payout policies?

Set a consistent dividend policy. Avoid cutting positive NPV projects to pay dividends. Over time, pay out all free cash flows.

Some research concerning mergers and acquisitions theorized that cash-rich bidders destroy what part of the firms free cash value?

Seven cents for every dollar bid

A firm can pay out its cash earnings to its shareholders in which of the following ways?

Share repurchase Dividends

How does the concept of limited liability apply to shareholders?

Shareholders cannot be held personally liable for the debts of the corporation.

Which of the following statements is/are true of the relationship between shareholders and the board of directors?

Shareholders elect the board of directors. The board of directors acts as a link between shareholders and management. The board of directors' role is to protect the interests of shareholders.

Which of the following are examples of investment policy distortion that can be caused by financial distress?

Shareholders may forego profitable projects if some of the benefits have to be shared with bondholders. Shareholders may pursue high-risk projects that could hurt bondholders. Shareholders may require additional dividend payments.

If the risk premium of stock MNO is 10 percent and the standard deviation is 40 percent, what is the Sharpe ratio?

Sharpe ratio = .1/.4 = .25

Which of the following would be consistent with market inefficiency?

Significantly negative serial correlation Significantly positive serial correlation

What are shareholders liable for if the firm is in financial distress and can pay only 80% of the payment due to the bondholders?

Since shareholders have limited liability, they are not personally responsible for the debt obligations of the firm.

Which of the following industries have high leverage ratios?

Steel Homebuilding

______-based insolvency is when a firm's assets are worth less than its debts.

Stock

An alternative way to pay out a firm's earnings to shareholders instead of cash dividends is a:

Stock repurchase

Who are the main claimants of a firm's cash flows?

Stockholders Bondholders Government

Why would a company with a record for steady dividends decide to issue new stock to pay dividends even in a lean year?

Stockholders prefer dividend stability

The market is known to react to unanticipated changes or surprises. Consider a stock return that is affected by inflation. What is the surprise in inflation (Finflation) if actual inflation is 9% and expected inflation is 7%?

Surprise = 9% - 7% = 2%

The market is known to react to unanticipated changes or surprises. Consider a stock return that is affected by inflation. How is the surprise in inflation (Finflation) estimated?

Surprise in inflation = Actual inflation - Expected inflation

Firm ABC is planning to acquire firm XYZ. The value of firm ABC is $20 million, the value of firm XYZ is $10 million, and the value of the combined firm (ABCZYZ) is $35 million. What is the synergy benefit from the proposed acquisition?

Synergy = 35 - (20 + 10) = $5 million

Firm A is planning to acquire firm B. The value of firm A is $50 million, the value of firm B is $22 million, and the value of the combined firm (AB) is $80 million. What is the synergy benefit from the proposed acquisition?

Synergy = 80 - (50 + 22) = $8 million

______ risk cannot be eliminated even after a merger leading to a more diversified firm.

Systematic

What type of risk should concern a well diversified investor who is adding new securities to a portfolio?

Systematic risk

Which of the following risks will not be eliminated by mergers?

Systematic risk

The return on any stock is expressed as follows: Actual return = Expected return + Unexpected return. Which of the following are components of unexpected return?

Systematic risk Unsystematic risk

Which type of risk does not change as we add more securities to a portfolio?

Systematic, or market, risk

A firm's target capital structure weights are evenly split between debt and equity. What is the firm's target debt-equity ratio?

Target D/E = .5/.5 = 1

Which of the following factors affect the establishment of a target debt-equity ratio?

Taxes Type of assets, tangible or intangible Uncertainty of operating income

Which of the following are reasons a firm would prefer a stock repurchase over dividends?

Taxes Undervaluation Flexibility

Which of the following are good reasons to lease instead of buy?

Taxes may be reduced. Certain types of uncertainty may be reduced Leasing may reduce transactions costs.

The economies of scale from a merger result from which of the following?

Technology Transfer Elimination of inefficient management Complementary resources

Which of the following are costs of issuing new securities?

The Green Shoe option The gross spread Underpricing

If an acquisition does not create value, and the market is "smart":

The PE ratio of the combined firm will adjust to something between the PE of the acquiring firm and the target

Which of the following could be used as a proxy for the market in a single factor model?

The S&P 500 Index

What does "market" generally refer to in the context of the single factor market model?

The S&P 500 index The securities market

Which of the following indexes is a good proxy for the market portfolio?

The Standard & Poor's 500 index

How does the level of debt affect the weighted average cost of capital (WACC)?

The WACC initially falls and then rises as debt increases.

Which act requires an acquiring firm to file with the SEC within 10 days of acquiring 5% of the target's stock?

The Williams Act

Which of the following happen in a merger?

The acquiring firm retains its name and identity The acquiring firm acquires all the assets and liabilities of the acquired firm The acquired firm ceases to exist as a separate business entity

What is the appropriate discount rate to use when discounting the cash flows from a lease?

The after-tax interest rate on debt

The given equation captures the portfolio return for an investor. Which of the following is true based on the given equation?

The beta for the portfolio is 1. The expected return on portfolio is 10%.

Who acts as a link between shareholders and top management?

The board of directors

How are preferred dividends different from interest on bonds?

The board of directors can choose not to pay preferred dividends even if the corporation is profitable. Nonpayment of preferred dividends does not lead to bankruptcy of the firm.

Whose interest does a deferred call provision protect?

The bondholders

How can the selfish stockholder strategy of taking more risk during periods of financial distress lead to agency costs?

The bondholders may get paid less with a high risk project relative to a low risk project.

Which of these statements is true regarding corporate capital structures?

The capital structure that maximizes the value of the firm provides the most benefit for its stockholders.

Which of the following is considered to be the main factor influencing a firm's dividend decision?

The consistency of its dividend policy

Who are the parties to the bond indenture agreement?

The corporation and the bondholders

What are the drawbacks of bearer bonds?

The corporation cannot get in touch with the bondholders directly. They are difficult to recover if lost or stolen.

A corporation gains no value from an interest tax shield if which of the following are true?

The corporation has no debt. The corporation is an all-equity firm. Corporate tax rates are zero.

An involuntary bankruptcy petition may be filed by creditors if both of the two conditions are met:

The corporation is not paying debts as they become due If there are more than 12 creditors, at least 3 must join in the filing. If there are fewer, then only one with a claim of $13,475 is required

Which of the following might explain why stock prices fall when a secondary offering is announced?

The costs associated with selling securities is substantial Managers believe that the stock is overpriced The firm's financial distress might be rising

Which of the following are financing side effects of leverage?

The costs of issuing new securities The tax subsidy to debt Other subsidies to debt financing The costs of financial distress

Which of the following are factors that affect beta?

The cyclical nature of revenues Financial leverage Operating leverage

Which of the following are examples of idiosyncratic risk?

The death of the CEO of a publicly traded corporation Management fraud leading to significant losses

What is synergy?

The difference between the value of a merged firm and the sum of the values of the firm as separate entities. The increase in value due to mergers

The fact that the average abnormal percentage return for mergers is positive during the 1980-2001 period may be outweighed by the fact that

The dollar value of aggregate mergers was negative.

The equity beta of a levered firm will always be ______ the equity beta of an otherwise identical all-equity firm.

The equity beta of a levered firm will always be higher than an otherwise identical unlevered firm, because the financial leverage adds risk to the firm's equity (because some cash flows belong to debt holders.) greater than

According to the capital asset pricing model, what is the expected return on a security with beta of 1?

The expected return on the market

A security has a beta of 1, the market risk premium is 8 percent, and the risk-free rate is 3 percent. What will happen to the expected return if the beta doubles?

The expected return will increase to 19% from 11%. 3% + 2 × 8% = 19%, which is an increase of 8%

Which of the following describe a firm that takes advantage of a reorganization?

The firm continues to operate. The business must have its reorganization approved by its creditors. It must liquidate its assets and end its operations. It is allowed to issue new securities.

Which of the following are examples of a negative covenant?

The firm is restricted from merging with another firm The firm may not pay excessive dividends

Which of the following are examples of a positive covenant?

The firm must maintain a debt ratio of 50%. The firm must furnish financial statements every quarter.

Why should a firm never give up a positive NPV project in order to pay a dividend?

The firm should accept all positive NPV projects. Doing otherwise would destroy firm value.

Which of the following are consequences of nonpayment of debt obligations?

The firm will encounter some form of financial distress A firm may be forced to file for bankruptcy.

Previously, a firm issued bonds at par with a 6 percent coupon. Today, similar bond yields are 8 percent and the risk-free rate is 3 percent. What is the embedded cost of the firm's debt?

The firm's embedded cost of debt is the coupon payment on previously issued debt. It is not related to the firm's cost of new debt. 6%

Who is likely to have the most information about a firm's future prospects?

The firm's manager

Based on historical data, which of the following are true about the market risk premium?

The historical market return for equities has been significantly higher (more than 5%) than the risk-free rate. The historical market risk premium for equities has been positive.

If a firm is in financial distress, who will get paid first?

The lawyers

Why is a manager with a small ownership interest in the firm more likely to indulge in wasteful behavior?

The manager bears only a small fraction of the costs but enjoys all the benefits.

Why are managers likely to work harder after an LBO?

The managers have greater ownership interest.

What is the slope of the security market line (SML)?

The market-risk premium

Which of the following are true?

The net present value computation includes all the cash flows. The present value computation ignores the initial investment.

Which of the following is likely to be true when a bankruptcy ruling is issued?

The ownership of assets is transferred from the shareholders to the bondholders.

Which of the following is true after an LBO?

The ownership pattern changes. The company is owned by a few investors.

Which of the following is true about spin-offs?

The parent company does not receive any cash. Shares are sent for free to the stockholders.

Which capital structure theory suggests that profitable firms will use less debt?

The pecking order theory

Which of the following are true?

The present value computation ignores the initial investment. The net present value computation includes all the cash flows.

How does present value (PV) differ from net present value (NPV)?

The present value of a project is determined before the initial investment is subtracted.

Which of the following usually occur with a stock dividend?

The price per share falls. No cash leaves the firm. The number of shares increase.

What is likely to happen to the share price if a company issues a stock dividend?

The price will fall.

What is the likely impact on a stock's price when dividends are paid?

The price will fall.

When the assets, liabilities and any non-controlling interest of an acquired firm are required to be reported at their fair market value, which one of the following methods is being used?

The purchase method

What can we conclude if the covariance between the returns of two securities is zero?

The returns of the two securities are unrelated.

What right does a proxy give to a shareholder?

The right to vote on behalf of another shareholder

What is the intercept of the security market line (SML)?

The risk-free rate

According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?

The risk-free rate of return Risk-free rate + 0 × Market risk premium = Risk-free rate

Why are shareholders more keen on investing in high-risk projects during times of financial distress?

The shareholders have will lose no more than they've already lost. High-risk projects offer the potential for a higher return for shareholders

A project costs $2,000 and will be financed by shareholders. The expected value of the shareholders' interest is $1,000 without the project and $2,500 with the project. Why will the shareholders reject this project?

The shareholders would invest $2,000 but receive only a $1,500 benefit. The bondholders would receive a $500 benefit at no cost to them.

Which of the following are stages identified in venture capital financing?

The start-up stage The first round financing stage The seed money stage

Which theory of capital structure leads to a target debt ratio?

The static trade-off theory of capital structure

What does a protective covenant involve?

The stipulation of actions that a company agrees to take The specification of conditions that a company must abide by

You conclude that a stock's return is determined by three factors: GNP, Interest rates, and inflation. You are given the following information on betas:βGNP=1.2, βinterest rate=1.5, βinflation= -1.3. What does the inflation beta suggest?

The stock's return will decrease by 1.3% for every 1% unanticipated increase in inflation.

You conclude that a stock's return is determined by three factors: GNP, Interest rates, and inflation. You are given the following information on betas:βGNP=1.2, βinterest rate=1.5, βinflation= -1.3. What does the GNP beta suggest?

The stock's return will increase by 1.2% for every 1% unanticipated increase in GNP.

Which of the following contributes to increasing debt capacity after a merger?

The target firm has a low debt level A merger can decrease the debt risk level

Of the four major financing side effects, which usually has the highest dollar value?

The tax subsidy to debt

What is shirking behavior?

The tendency to work less because of the incentive structure.

A stock split increases the number of outstanding shares, while ___.

The total owners' equity remains constant

The potential gains from an acquisition include which of the following?

The use of surplus funds. The use of tax losses.

Suppose the value of Firm X's stock is $30, and it currently has 50 shares outstanding. Firm Y has 25 shares outstanding at a price of $20. Firm X is planning to exchange 20 Firm X shares for all 25 shares in Firm Y. If the post-merger value of the combined firm is $2200, what is the cash equivalent cost of this exchange?

The value of Firm Y shareholder's portion of the new firm is [20/(50+20)]*2200=628.57

What do Modigliani and Miller assert about the relationship between leverage and firm value in the presence of corporate taxes?

The value of the firm increases with leverage.

What must the x-axis represent in this graph that shows the relationship between number of securities in a portfolio and risk?

The x-axis represents the # of stocks in the portfolio.

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.

Under what condition are firms legally required to distribute dividends to shareholders?

There is no legal requirement to pay dividends every year.

What is the minimum annual dividend distribution requirement for a publicly traded corporation?

There is no requirement to distribute dividends.

If a stock's returns are uncorrelated with inflation, what would be the impact of higher than expected inflation on the stock's returns?

There would be no effect on the stock's returns.

Which of the following are true about U.S. Treasury instruments?

They are not expected to default at this time. They have never defaulted.

What is the attraction of issuing Eurobonds?

They are not subject to the same restrictions as a domestic bond.

What do covariance and correlation measure?

They both measure how two random variables are related

Which of the following are true about optimal portfolios?

They provide the best risk-return trade-off. They offer the highest return for a given level of risk. They offer the lowest risk for a given level of return.

What do the factors represent in the multi-factor model of APT?

They represent risks that cannot be diversified away.

What do the betas represent in the multifactor version of the APT?

They represent the security's beta with respect to each factor.

What is the role of expert witnesses?

They testify about the fairness of a proposed settlement.

Which of the following is true about arbitrageurs?

They trade mispriced securities. They play an important role in restoring equilibrium price in competitive markets. They attempt to make riskless profits.

What is the benefit of writing protective and restrictive covenants into loan contracts?

They will lower the interest rate on bonds.

Why are the deviations of returns squared when computing variance?

This ensures that that the sum of the deviations is a positive number.

Which of the following is an argument against shelf registration?

Timeliness of disclosure is reduced.

Which of the following are reasons for reverse stock splits?

To eliminate small shareholders To comply with listing requirements To raise stock prices to respectable levels

Which of the following is the primary motive for creating dual or multiple classes of stock?

To maintain control of the firm

What is the general objective of corporate reorganization?

To restructure the corporation with provision for repayment of creditors

In a publicly traded corporation, which of the following is true regarding the relationship between the board of directors and management?

Top management is hired by the board of directors. The board of directors advises and oversees the work of management.

What is the total return if the expected return is 2%, the systematic portion of the return is 6%, and unsystematic portion of the return is 3%?

Total Return = 2% + 6% + 3% = 11%

What is the total return if the expected return is 4%, the systematic portion of the return is 3% and the unsystematic portion of the return is 2.5%?

Total return = 4% + 3% + 2.5% = 9.5% 9.5%

What observations can we make from this graph that shows the relationship between total risk (Y-axis) and number of securities in a portfolio (X-axis)?

Total risk is reduced as the number of securities increases. Systematic risk is not affected by the number of securities in the portfolio. Unsystematic risk decreases as the number of securities increases.

True or false: A pre-emptive rights offering grants existing shareholders the right to buy new shares so they can keep their proportional ownership the same.

True

In 2010, the U.S. collected over $400 billion in corporate taxes. What do these figures suggest about the capital structure choices of U.S. firms?

U.S. firms do not use enough debt to capture all the tax shield benefits of debt.

ULC and LEV have earnings before interest and taxes of $110. LEV also has $20 of interest expense. Both companies are taxed at 30%, ULC's aftertax earnings are ___ , which is ___ than LEV's aftertax earnings (assume all interest can be deducted).

ULC = $110 × (1 - .3) = $77 LEV= $90 × (1 - .3) = $63 $77; $14 greater

In the ______, debentures are unsecured debt; in the ______, debentures are secured debt.

US; UK

Which one of the following is true?

Under U.S. tax law, a corporation's interest payments up to 30% of EBIT are tax deductible.

______ helps new shareholders earn a higher return on the shares they buy.

Underpricing

What is the maximum number of classes of common stock that a publicly traded corporation can issue?

Unlimited

Which creditors usually take the brunt of a bankruptcy?

Unsecured creditors

A well diversified investor need not worry about this type of risk while adding new securities to a portfolio?

Unsystematic risk

Which type of risk can be reduced or eliminated through effective diversification?

Unsystematic risk

Which of the following is/are true of venture capitalists (VCs)?

VCs play an active role in overseeing the companies in which they invest. VCs usually don't want to own an investment forever

What is the expression for the value of a levered firm in the presence of corporate taxes?

Value of Levered Firm = Value of Unlevered Firm + Tax Benefit of Debt

How many variance and covariance terms will be needed in order to calculate the variance of a portfolio consisting of 100 stocks?

Var terms = 100 Cov terms = N2 - N = 1002 - 100 = 9,900 100 variance terms and 9,900 covariance terms

Which of the following are true?

Variable costs change with changes in quantity. Fixed costs do not change as quantity changes.

The ______ is the overall expected return the firm must earn on its existing assets to maintain its value if the firm is levered.

WACC

Typically, which capital budgeting technique(s) is/are used?

WACC FTE

What is the standard deviation (SD) of a portfolio that includes a risk-free security and a risky security?

WeightRisky × SDRisky

According to the CAPM, when is a security considered overpriced?

When its expected return plots below the SML

What are some possible consequences of raising debt to fool the market about a firm's value?

When the market discovers the truth, share prices will drop. The probability and expected costs of financial distress will increase if debt rises above the optimal level.

Why will a firm prefer to issue debt if there are no personal taxes and no financial distress costs?

While debt holder income is not affected by corporate taxes, shareholder income is reduced by corporate taxes.

If ABC corporation issues convertible preferred stock to XYZ corporation, what is the potential impact on the future ownership structure of ABC corporation?

XYZ corporation may enjoy ownership at ABC corporation.

According to the clientele effect, can a firm boost its share price by raising dividends?

Yes, but only if an unsatisfied clientele exists

If a stock has returns of 10 percent and 20 percent over 2 years, the geometric average rate of return can be calculated by ____.

[(1.10)(1.20)].5 - 1

B = the market value of a firm's debt; S = the market value of that same firm's equity; RB = the before-tax yield on the firm's debt; TC = the corporate tax rate; RS = the cost of equity. Given the definitions above, the weighted average cost of capital formula can be written as:

[S/(S+B)]×RS + [B/(S+B)]×RB×(1-Tc)

The market return used in the abnormal return definition is based on ___.

a broad-based stock market index

Which of the following are examples of perquisites?

a company car a big office use of a company jet

Which of the following describes insolvency?

a condition in which assets are insufficient to discharge liabilities lack of means of paying one's debts inability to pay one's debts

If a firm has multiple projects, each project should be discounted using ___.

a discount rate commensurate with the project's risk

Firms with secured creditors and trade creditors will usually use _______.

a formal bankruptcy

An ice cream distributor with a distribution network of refrigerated trucks and retail outlets has found that its trucks are not completely full. It is considering making an acquisition. What is the best acquisition to take advantage of complementary resources?

a frozen dinner distributer

In a world with corporate taxes, we determine the increase in the firm's optimal debt level by discounting:

a future guaranteed after-tax inflow at the after-tax riskless interest rate

An investor who invests in the stock of a levered firm rather than in an all-equity firm will require ___.

a higher expected return

Subsidized, non-market-rate financing has ______ rate as market-rate financing.

a lower

A line of credit from a bank sets ______ amount the bank is willing to lend.

a maximum

In bankruptcy lingo, a vulture is:

a money manager who specializes in securities of distressed an defaulted companies

The rule on stock price dilution states that the stock price falls if the firm issues stock to fund a project with:

a negative NPV

A higher dividend might signal ___.

a possible sell off of valuable assets a decrease in capital investments a higher estimated cash flow

Underpricing a securities issue mitigates the problem of:

a price drop causing a loss in an underwriter's holdings of the security an underwriter being sued by angry investors for selling overpriced securities

Leverage increases a firm's equity beta less rapidly under corporate taxes because it creates:

a riskless tax shield that lowers the risk of the entire firm

In a leverage buyout the equity capital is generally supplied by

a small group of investors, some of whom are likely managers.

An abnormal return is defined as ___.

a stock's actual return minus the market return

A direct loan that matures in one to five years and is repayable during the life of the loan is known as:

a term loan a tender offer

When a firm avoids a hostile acquisition by turning to a friendly bidder, that friendly bidder is referred to as:

a white knight

An event study used to determine the value of a merger records ______ stock returns on and around the merger date.

abnormal

Cumulative abnormal returns are the sums of the daily ______ returns.

abnormal

According to the CAPM, a security is considered underpriced when its expected return plots ___ the SML.

above

In terms of financial distress, APR refers to:

absolute priority rule

The evidence about the results of a buyout for the combined firm is ambiguous, but the evidence is clear that the stockholders of the _____ benefit from the merger.

acquiring firm

As debt is ______ the capital structure, the present value of financial distress costs ______.

added to; increases

The weighted average cost of capital is determined by:

adding the weighted average after-tax cost of debt to the weighted average cost of equity

Subsidies to debt financing ______ value.

adds

The weighted-average cost of capital requires the ______-tax cost of debt.

after

In a world with corporate taxes, a firm should discount the riskless cash flows at the ______ riskless rate of interest.

after-tax

The optimal level of debt is determined by discounting future guaranteed _____ cash inflows using the _____ riskless interest rate.

aftertax; aftetax

A firm might use higher dividends or stock repurchases to reduce ______ costs.

agency

An example of an _______cost is when a firm issues more equity and an entrepreneur increases leisure time.

agency

An example of an_______ cost is when a firm issues more equity and an entrepreneur increases leisure time.

agency

Having too much cash can cause an ______ cost.

agency

Having too much cash can cause an _______ cost.

agency

Percentage abnormal returns for the bidder's stockholders have been positive in all sub-periods, but

aggregate dollar returns are negative in all sub-periods,

If investors have homogeneous expectations, they ___.

all possess the same estimates regarding expected returns, variances, and covariances

Effective control of a target firm can be obtained through a proxy contest if:

an acquirer's candidates win a majority of seats on the board.

A standstill agreement is:

an agreement made by the acquiring firm to limit its holdings in the target firm

An offer from a firm to buy stock that intentionally leaves out targeted stockholders is called:

an exclusionary self-tender

What is a debenture?

an unsecured bond

If you can beat the market by _____ then you are violating weak form efficiency.

analyzing historical price patterns

An assumption underlying Modigliani and Miller's dividend irrelevance proposition is that the investment policy of the firm is set ahead of time ___.

and is not altered by changes in dividend policy

The opponents of efficient market theory point out the large number of ______ cannot simply be attributed to chance alone.

anomalies

A real world example that does not support market efficiency is called a(n) ______.

anomaly

A real world example that seems to contradict market efficiency is called a(n):

anomaly

Most public firms (83%) that file for Chapter 11 bankruptcy

are able to reorganize and continue to do business

Financial leases:

are fully amortized

When choosing between exercising or selling rights, shareholders:

are indifferent

Dividends ______ business expenses.

are not

Markets are more likely to be efficient if the investors ___.

are rational use relevant information to make a trade

Under the MM propositions with no taxes, managers cannot change the value of the firm by repackaging its securities because __.

as debt is added, the equity becomes more risky the overall cost of capital cannot be reduced

Collateral refers to any:

asset pledged on a debt

If a manager has more information than an investor about the firm, that information is referred to as ____ information.

asymmetric

The standard deviation decreases over the ______ bending portion of the feasibility set.

backward

Under the FAS 13, where does the present value of finance lease payments appear?

balance sheet

A Z-score of less than 1.81 predicts that a firm will:

be bankrupt within a year

A rational shareholder will subscribe to a rights offering only if the subscription price is ______ the market price of the stock on the expiration date.

below

A rational shareholder will subscribe to a rights offering only if the subscription price is:

below the market price of the stock on the offer's expiration date.

Under the ______ method, the underwriter sells as many shares as possible but may or may not sell all of the new shares.

best efforts

CAPM suggests that the expected return on a security is linearly related to its .

beta

CAPM suggests that the expected return on a security is linearly related to its _________

beta

In the APT, betas represent the security's _____with respect to each factor.

beta

The covariance between the stock and the market index's returns divided by the variance of the market index's returns represents the ______for a company's stock.

beta

The covariance between the stock and the market index's returns divided by the variance of the market index's returns represents the _____for a company's stock.

beta

The slope of the characteristic line of a firm's returns versus those of the market is the ___.

beta

When calculating the cost of equity capital using the security market line, the risk-free rate is added to:

beta times the difference between the expected return on the market and the risk-free rate

A firm that has decided to take over another firm is usually referred to as the ______.

bidder acquirer

A mortgage that pledges all the real property owned by the corporation is known as a:

blanket mortgage

A deed of trust is also known as a:

bond indenture

In a shareholder-bondholder relationship, the ______ is the principal.

bondholder

During bankruptcy, the ownership of the firm's assets is transferred from stockholders to ___.

bondholders

Protective covenants are designed to protect the interests of the:

bondholders

In the coinsurance effect:

bondholders gain and stockholders lose, assuming no synergy

Corporate treasurers prefer to use ______ values when calculating debt ratios.

book

_______is the process that determines the best offer price.

bookbuilding

Which of the following matter to capital structure?

both corporate and personal taxes

Venture capital commitments tend to increase during:

bull markets

If there is a deferred call provision, whereby the corporation is prohibited from recalling the bonds, the bonds are said to be:

call protected

A callable bond:

can be called and redeemed by the corporation before the maturity date

The excess rate of return ____.

can occasionally be negative is generally positive over the long-term

According to the theory of efficient markets, managers ______ create value by fooling investors.

cannot

If a point plotted above the security market line (SML) represents a project being considered by an all-equity firm, the project's IRR must be greater than the cost of ______.

capital equity

An important advantage to a firm raising equity internally is not having to pay ___.

capital gains

A firm will find it difficult to put together a private workout if they have a complicated:

capital structure

When a firm turns a division into a separate entity and then sells shares in the division to the public, it is referred to as a:

carve-out

An increase in free ________flow tends to increase wasteful spending.

cash

Firm A's stock price is $34. Managers in Firm A believe the stock is worth $40. Will they be more likely to pay for an acquisition using cash or stock?

cash

When calculating the cash flow for a levered firm, you must consider

cash flows to both bondholders and stockholders

The difference between general cash offers and rights offers is that ___.

cash offers are offered to the general public and rights offers are offered first to existing shareholders

Homemade dividends allow a stockholder to change the ___.

cash payout received by selling shares to receive current cash or purchasing additional shares to reduce current cash

A firm can benefit from financial distress by:

changing its behavior

the __________ , line shows a security's return in relation to the market's return.

characteristic

A firm can limit the ______ effect by retiring its debt before the merger announcement date and reissuing an equal amount of debt after the merger.

coinsurance

Junior debt cannot be subordinated to:

common stock

A negative covenant restricts the actions of the ______.

company

Managers may be concerned about the drop in earnings per share (EPS) that may occur when new shares are issued to fund a positive NPV project because their _______ is frequently based on EPS.

compensation

A ski equipment store merging with a tennis equipment store is an example of improving operating efficiency through:

complementary resources

Financial distress will be cheaper if:

complexity is low and information is complete

The arithmetic average return ignores

compounding

A merger in which both the acquiring firm and the acquired firm cease to exist and a new entity is formed is referred to as a:

consolidation

A positive coefficient of serial correlation for a particular stock indicates a tendency towards _________, which means that a higher-than-average return today is likely to be followed by higher-than-average returns in the future.

continuation

Plain vanilla bonds are:

conventional bonds with typical bond features

The articles of incorporation and corporate bylaws governing a firm make up the:

corporate charter

The challenge of holding managers accountable for their actions is the subject of:

corporate governance agency theory

Voluntary bankruptcy is filed by the ___________.

corporation

A positive covenant specifies an action or rule that a:

corporation must abide by

Serial ________ is the relationship between the current return on a security and the return on the same security over a later period.

correlation

Generally, which is easier to determine?

cost of debt

Monitoring can reduce agency costs from leases and monitoring is:

costly

Dividends and capital gains given to the new shareholders represent ______ to the firm.

costs

Two ways to measure the relationship between the returns of two securities are ______ and ______.

covariance correlation

Since it is difficult to find financing opportunities with positive net present values when capital markets are efficient, firms must:

create value in other more difficult ways

Involuntary bankruptcy is filed by the:

creditors

If a firm must liquidate, the proceeds are distributed to:

creditors in order of established priority

If a corporation is not paying debts as they become due,

creditors may file for involuntary bankruptcy

With a _____________ preferred dividend, unpaid dividends are held in arrears and may be paid out at some future date.

cumulative

In general, financial companies in the US typically issue:

debentures

A lease is in lieu of:

debt

In a world with no financial distress where dividends and interest are taxed at the same personal rate, firms will prefer to issue ______.

debt

Should a firm issue debt or equity if both dividend income and interest income are taxed at the same rate? Assume there is no prospect of financial distress.

debt

The net present value of ______ is likely to be the sum of the tax effects, flotation costs, bankruptcy costs, and interest subsidies?

debt

The value of a levered firm is higher than the value of an unlevered firm in the presence of corporate taxes owing to the tax shield benefit of:

debt

To find the NPV of leasing relative to purchasing, one can discount all cash flows at the after-tax interest rate or compare the purchase price with the reduction in the optimal ______ level under leasing.

debt

Cash flows from a lease are similar to:

debt payments

The value of a firm is equal to the value of its:

debt plus equity

Firm value initially increases when the proportion of debt in the capital structure increases due to the ___.

debt tax shield

The WACC is the weighted average cost of ______ plus the weighted average cost of ______.

debt; equity

DIP debt refers to:

debtor in possession debt

The date on which the company's board of directors passes a resolution to pay a dividend is called the ______ date.

declaration

If a firm is in financial distress and wants to plan a restructuring, it should

declare Chapter 11 bankruptcy

When a secondary offering is announced, stock values tend to:

decline

According to DeAngelo, DeAngelo, and Skinner, the percent of public firms that pay dividends has ______ over time.

declined

The ratio of total debt to the book value of equity for US nonfarm, non-financial firms has ______ over time.

declined

As more securities are added to a portfolio, the unsystematic risk tends to ______.

decrease

The risk of a large, diversified portfolio will ____ if a security with a negative beta is added to the portfolio.

decrease

With taxes, the weighted average cost of capital ______ as debt is added to the capital structure.

decreases

U.S. Treasury securities considered to be risk-free because they have minimal, if any, ____ risk.

default

Manufacturers can ______ profit if they are the ______.

defer; lessor

When a corporation is prohibited from calling bonds for 7 years, it is subject to a(n):

deferred call provision

Behaviorally, investors tend to ______ current income.

desire

Investment banks aid corporations with stock issues by:

developing a strategy to issue the securities selling the securities pricing the new securities

The higher returns from value stocks could be due to ___.

differences in risk biases in commercial databases

Different types of information will affect stock prices ______.

differently

Rights offerings can avoid ________of ownership of existing shareholders.

dilution

ABC Company leases a computer system from an independent leasing company that purchases the system from the manufacturer. This is an example of a ______ lease.

direct

Legal costs are typically the most important component of _____costs.

direct

The two broad types of costs of financial distress are ___ costs.

direct and indirect

A firm shouldn't issue new shares of stock to pay dividends because of the ___.

direct costs of issuance tax consequences

Dividends are tax ______ relative to capital gains.

disadvantaged

If the corporate income tax were repealed. long-term leasing would probably:

disappear

The rate used to discount project cash flows is known as the ___.

discount rate required return cost of capital

Firms should ______ riskless cash flows at the ______ riskless rate of interest

discount; aftertax

Dividends can be classified as a(n):

discretionary distribution

Financial ______ means a firm cannot meet its financial obligations.

distress

Financial ______costs lower the value of the levered firm.

distress

A(n) ________ occurs whenever a firm makes a payment to its owners from a source other than current or accumulated retained earnings.

distribution

When an individual adds securities to their portfolio that are less than perfectly positively correlated they benefit from:

diversification

The sale or spin-off of a division of a corporation is known as a(n) ______.

divestiture

The ______discount model for a stock can be generalized to the market as a whole.

dividen

When a payment is made from a firm's earnings to its owners in the form of cash, it is called a _____.

dividen

The value of a share of stock should be equal to the present value of its future expected ______ payouts

dividend

One method for estimating the cost of equity is based on the ______ model.

dividend discount

Which of the following are differences between interest payments and dividend payments by the corporation?

dividend income is not fixed while interest income is generally fixed dividends are paid to stockholders while interest is paid to bondholders dividend payments are not an obligation but interest payments are an obligation

Common stockholders receive ______ income while bondholders receive ______ income.

dividend; interest

Stock splits and stock __________ have essentially the same impacts on the corporation and the shareholder.

dividends

The decline in the ratio of total debt to the book value of equity for US nonfarm, non-financial firms declined modestly from 1995 to 2013. This modest decline is understandable because as long as net income exceeds __________, retained earnings will be positive, raising the book value of equity.

dividends

U.S. firms ______ use enough debt to capture all the tax shield benefits of debt.

do not

The empirical evidence on median debt-to-value ratios for countries around the world indicates that real world companies ___.

do not issue enough debt to significantly reduce or eliminate corporate taxes

In the graph to the right, asset B is mispriced because it:

does not fall on the security market line. has a lower return than asset P even though both assets have the same risk.

If a Japanese firm believes the yen will increase relative to the dollar, then that firm will want to issue debt that is denominated in ___.

dollars

A cyclical firm is one in which revenues go ______ in the contraction phase of the business cycle.

down

Shelf registration allows firms to use the _________ method of new equity issuance

dribble

A project with big growth in earnings over time may reduce __________ initially because the project does not generate any cash flow initially.

earnings per share

If an acquisition does not create value, then the:

earnings per share can change but the stock price of the acquiring company should remain constant.

Financial leverage affects the performance of a firm because the range of possible values for ___.

earnings per share is wider

Venture capital investments are strongly influenced by:

economic conditions

Increased cost reduction efficiencies following a merger can result from:

economies of scale technology transfer

Market implies that stock price changes are informative to managers.

efficiency

In an ___________ stock market it will make no difference whether new stock is obtained via rights or via direct purchase.

efficient

The purpose of event studies is to test whether or not stock markets are ______.

efficient

The value of a project to a levered firm (APV) is ______ the value of the project to an unlevered firm (NPV) plus financing side effects (NPVF).

equal to

A firm should only undertake a project if its expected return is ______ that of a financial asset of comparable risk.

equal to or greater than

A seasoned_______offering is a new issue where the company's stock securities have previously been issued.

equity

No exact formula exists to evaluate the optimal debt-______ ratio.

equity

One recent study found that in 81 percent of recent bankruptcies the _____ investor obtained some compensation, despite the absolute priority rule.

equity

The Flow to Equity (FTE) approach to capital budgeting calls for discounting the cash flow from the project to the equity holders of the levered firm at the cost of _____capital.

equity

The asset beta is the beta of common stock had the firm been all ____

equity

The asset beta is the beta of common stock had the firm been all____

equity

The average excess return on common stocks is called the ______ risk premium.

equity

The two main types of securities issued by a corporation are debt securities and ______ securities.

equity

Typically, which of the following has the highest flotation costs?

equity

Venture capitalists typically fund start-ups using what method?

equity

The lack of information concerning a financially distressed firm's cash flow favors:

equity holders

Under the purchase method, the acquiring firm

establishes a new cost basis for the acquired assets.

If a U.S. firm believes the euro will decline relative to the dollar, then that firm will want to issue debt that is denominated in ___.

euros

In order to receive a dividend, a stockholder must purchase stock before a certain date. That date is called the ___.

ex-dividend date

The use of fraudulent accounting methods can cause a company's stock price to ___.

exceed its fair value

In a tax-free acquisition the shareholders of the acquired firm are considered to have:

exchanged their old shares for new ones of equal value

Shareholders are indifferent between:

exercising and selling rights

A pre-emptive rights offering grants ____.

existing shareholders the right to buy new shares

A financial deficit is generally made up through ______ financing.

external

A financial deficit is covered with:

external financing

A stock's price tends to ______ when dividends are paid.

fall

The underwriters accept the risk that the market price may ______ between the date the price is set and the time the issue is sold.

fall

When raising debt to fool the market, the stock price will _____ when the market realizes the company tried to fool it.

fall

MM's assertion of a positive relationship between firm value and leverage is widely observed in the business world.

false

True or false: A merger tends to benefit the bidder's shareholders.

false

True or false: Corporate managers can consistently manipulate and fool the market.

false

True or false: Firms are able to completely hide operating lease activity.

false

True or false: Firms lose tax carryforwards in bankruptcy.

false

True or false: Holding equity in an unlevered firm has no risk.

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: If a firm stays in the same industry, its beta will never change.

false

True or false: Independent deviations from rationality means markets are inefficient.

false

True or false: Individual stockholders are able to efficiently affect the decisions of management.

false

True or false: It is not possible for some stocks to have negative inflation betas and other stocks to have positive inflation betas.

false

True or false: Protective covenants are classified as either direct or indirect covenants.

false

True or false: Tax reduction is seldom a motive for acquisitions.

false

True or false: The CAPM is the only method to compute the cost of equity.

false

True or false: Typical capital budgeting situations will be more amenable to the APV approach.

false

True or false: US firms pay no dividends because of their tax disadvantage.

false

True or false: Very few firms in the real world have target debt ratios.

false

True or false: We cannot put too much confidence in conclusions derived from empirical models of asset pricing.

false

The range of risk-return combinations possible with a portfolio of securities is captured by the opportunity set, which is also known as the ______ set.

feasible

In general, a Eurobond will have ______ restrictions than a domestic bond.

fewer

The Williams Act of 1968 requires firms acquiring more than 5% of a company's stock to:

file a Schedule 13D with the SEC within 10 days provide detailed information including its intentions and its position in the target

Firms faced with financial distress deal with it by:

filing for bankruptcy selling major assets

The payment to lawyers become relevant in the context of capital structure decisions in the event of ____.

financial distress

The resignation of a firm's CEO might signal:

financial distress

When a firm has insufficient cash flow to make contractually required financial obligations, it is in:

financial distress

The weighted average cost of capital rises at higher levels of debt owing to:

financial distress costs

An increase in a firm' s level of debt is an example of ___.

financial leverage

An increase in ______ will increase beta.

financial leverage operating leverage

A firm in financial distress might seek a merger with a:

financially stronger firm

The types of equity and debt to sell is an example of a(n):

financing decision

A standby underwriting arrangement in conjunction with a rights offering gives the ___.

firm an alternative avenue of sale to ensure the success of the rights offering

The value of the firm is given by the following expression:

firm value = value of equity + value of debt

The elimination of one of the two buildings used for corporate offices after a merger is an example of reduction in ______ capital.

fixed

The principal and coupon payments are ______ for a conventional bond.

fixed

______costs do not change as the quantity sold changes while _____costs do change as the quantity sold changes.

fixed variable

All firms must invest in:

fixed capital working capital

The issuance costs of bonds and stocks are referred to as ______ costs.

flotation

The costs incurred by a company when it issues new financial securities such as stocks and bonds are known as:

flotation costs

The inability to pay one's debts is referred to as ______ insolvency.

flow-based

Two types of insolvency are:

flow-based and stock-based insolvency

Empirical models of asset pricing:

focus more on historical market data than on financial theory

As _________ cash flow increases, wasteful activity in the firm tends to increase.

free

When two firms negotiate a merger in good faith and cooperation it is referred to as a:

friendly takeover

Which of the following might be likely angel investors for a start-up company?

friends family members

Which of the following is equity offered to any interested investor?

general cash offer

In bankruptcy cases, the claims of lawyers are _____ the claims of senior bondholders.

given priority over

When a firm is liquidated, the result is that it ceases as a _____________.

going concern

The strategy of creating a generous severance package for a firm's top management in defense of a takeover is referred to as a:

golden parachute

What is the name for the excess of the purchase price over the sum of the fair market values of the individual assets acquired?

goodwill

Levered equity has ______ risk than unlevered equity.

greater

With taxes, MM Proposition I says the value of the levered firm will be _____ the value of the unlevered firm.

greater than

The cost of a stock-for-stock acquisition is:

greater than a cash-for-stock acquisition

Financial managers try to package securities to receive the _____ value.

greatest

A targeted repurchase, in which a firm buys back its own stock from a potential bidder, is often called

greenmail

To apply the dividend discount model to a particular stock, you need to estimate the ___.

growth rate dividend yield

An unlevered firm ____.

has an all-equity capital structure

To a tax-paying stockholder, a stock repurchase ___.

has significant tax advantages compared to a cash dividend

Empirical models using historical data ______ been quite useful in understanding the behavior of security returns.

have

Due too financial distress, shareholders may invest in ______ risk projects, at the expense of bondholders.

high

A portfolio with a P/E ratio that is significantly greater the market's average P/E ratio might be characterized as a(n):

high P/E stock portfolio growth stock portfolio

Firms that issue ______ amounts of debt may also lease equipment frequently because the corporate attributes that provide _______ debt capacity may also make leasing advantageous.

high; high

Firms in which managers have ______ equity ownership tend to have ______ leverage.

high; lower low; higher

IPOs have slightly _______ expenses than SEOs.

higher

If markets are efficient, then portfolios with more risk will earn ______ return.

higher

Industries with ______ levels of investment in tangible assets are likely to have higher debt ratios.

higher

One argument against efficient markets is that stocks with high earnings-to-price ratios (value stocks) have ______ returns than stocks with low earnings-to-price ratios (growth stocks).

higher

The optimal debt-equity ratio will be ______ in a world with agency costs of equity than in a world without these costs.

higher

In the real world, firms with high levels of investment in tangible assets will have ___.

higher target debt-equity ratios

The P/E ratio for a growth portfolio will be:

higher than the market's average P/E ratio

Managers should choose the capital structure that will have the ______ firm value.

highest

An accounting balance sheet uses ______ values and a market balance sheet uses ______ values.

historical; current

Investors are indifferent to a firm's dividend policy because they can undo undesirable dividend policy decisions using ___.

homemade dividends

An individual can duplicate a levered firm through a strategy called ____ where the investor uses his own funds plus borrowed funds to buy stocks.

homemade leverage

When an investor borrows money and uses it to purchase stocks is called

homemade leverage

When valuing a complete business enterprise, the same process that is used for individual projects can be used. However, the analysis is complicated because a _________ must be used, and a terminal firm value must be determined.

horizon

The acquisition of another firm in the same industry is called a:

horizontal acquisition

An acquisition that is resisted by the targeted firm is known as a(n) ______ takeover.

hostile

Typical financing decisions include:

how much equity and debt to sell the types of equity and debt to sell when to sell equity and debt

A manager of a firm with excess cash could create an agency problem:

if they receive a bonus for acquiring other firms because their prestige is often based on the size of the firm if their pay is based on the size of the firm

A world where all investors possess the same estimates of expected returns, variances, and covariances is:

imaginary

An efficient market is one in which any change in available information will be reflected in the company's stock price ___.

immediately

If company managers believe interest rates will rise, they have a(n) _________ to borrow long term.

incentive

Analysis of the cash flows of a lease requires one to account for _________ cash flows

increamental

If company managers believe interest rates will rise, they will _____ borrowing now.

increase

In the presence of corporate taxes, the tax shield effect of debt will ____ the value of the firm.

increase

The value of a firm will ______ when the firm first uses leverage if we assume that there are no bankruptcy costs.

increase

When issuing securities with tax breaks, a firm can ______ value.

increase

A one-for-five reverse stock split will ___.

increase a $1 par value to $5

According to the efficient markets theory, the announcement of a future plant expansion (with a positive NPV) should cause the stock price and therefore the value of the firm to ___.

increase immediately

Financial leverage _____ risk to the firm's equity.

increases

Volatility in income ______ the probability of financial distress.

increases

Non-market-rate or subsidized financing:

increases APV

Whenever the cost of capital for an all-equity firm is greater than the cost of debt, the cost of equity ___.

increases with leverage

In bank mergers, the stock of the target bank usually ______ upon the first announcement of the merger, and the stock of the acquiring bank usually ______.

increases; decreases

The expected return on the market will increase if the risk-free rate _________ or if the market risk premium _____.

increases; increases

To test semistrong market efficiency, we can compare actively managed mutual funds with ___.

index funds

Investors are ________ towards dividend policy due to ______ dividends.

indifferent; homemade

An efficient market is one that fully reflects all available ______.

information

The first public equity issue made by a firm is called a(n) ___.

initial public offering

It is not uncommon for IPOs to ______ experience large gains.

initially

Which of the following are lenders of term loans?

insurance companies commercial banks

With an operating lease, the lessor may have to _____.

insure the leased asset sell the asset for its residual value maintain the leased asset

In reality, most firms cover the equity portion of their capital spending with ___.

internally generated cash flow

If a cash offer is public, a(n) ______ bank is usually involved.

investment

Risk that is diversified away ______ by the APT.

is not

Under the dividend irrelevance proposition, Miller and Modigliani assume that firms investment policy ______.

is set ahead of time and never changes

The effect of financial leverage ______ for all earning levels.

is variable

If managers who want to issue equity believe the company's stock is overpriced, they are likely to ___.

issue equity immediately

In order to increase management's voting control, a firm might:

issue new stock to management

One drawback of acquiring assets instead of acquiring stock is that:

it can be costly to transfer titles

A market value balance sheet differs from an accounting balance sheet because ___.

it does not use historical values

Behavioral finance indicates dividends solve the problem that investors ______ self control.

lack

According to behavioral finance studies, firms pay dividends because investors ___.

lack self-control

What happens to book value per share when new shares are issued is:

largely irrelevant

The industry beta may be a better estimate than the firm's own beta due to the ______ standard error of the firm estimate.

larger

The underwriter spreads are smaller on:

larger issues

Nonmarketable claims include claims of the ____.

lawyers government

If the net present value of the incremental cash flows from leasing relative to purchasing is positive the firm will prefer to _______ the asset.

lease

Which of the following is a contractual agreement that gives a person or firm the right to use an asset in return for a monthly payment?

lease

Debt displacement is a hidden cost of:

leasing

After an LBO, managers are likely to shirk ___.

less

Empirical models rely ______ on theory than does the CAPM or APT.

less

Flotation costs for issuing debt are usually ______ than flotation costs for a comparable equity issue

less

Which of the following is an argument against shelf registration?Flotation costs for issuing debt are usually ______ than flotation costs for a comparable equity issue

less

An individual will work _______ if they own a ______ percentage of the company.

less; smaller harder; larger

The user of a leased asset is the _____.

lessee

An operating lease has a cancellation option which allows the _____.

lessee to cancel the lease before the expiration date

The owner of a leased asset is the _____.

lessor

The residual value of a leased asset belongs to the _____.

lessor

Even with efficient markets, investors must worry about their ___.

level of risk exposure degree of diversification

APV and WACC are similar in that they reflect the tax benefit of ______.

leverage

In a _____ , _____ Correct Unavailable, the APV approach is preferred.

leverage, buyout

A going-private transaction where the outstanding shares of stock are purchased largely with borrowed money is referred to as a:

leveraged buyout

A lease that requires the lessor to fund 50% or less of the purchase price is called a(n):

leveraged lease

A firm with debt in its capital structure is said to be:

levered

The debt tax shield increases the value of the ______ firm.

levered

MM Proposition I does not work with corporate taxes because:

levered firms pay lower taxes than unlevered firms

Royal Dutch and Shell shares not trading at parity is an example of:

limits to arbitrage a market anomaly

A distribution from capital is referred to as:

liquidating dividend

Liquidation differs from reorganization in that:

liquidation terminates business activity while reorganization allows the firm to continue operating

An agreement in an underwriting contract that prohibits insider shares from being sold immediately following an IPO is called a _______ period.

lockup

Dilution is defined as a(n) ____.

loss in existing shareholders' value

The debt displacement of leasing will add costs to the firm through:

loss of tax advantages

What are some examples of indirect financial distress costs?

lost sales lost reputation

Leasing can circumvent laws against charging too ______ a price.

low

Bankruptcy costs are likely to be ______ if there are fewer groups of lenders.

lower

Industries with high growth rates are likely to have ______ debt ratios.

lower

Protective covenants typically ______ interest rates.

lower

The costs associated with selling debt are substantially ______ than the costs of selling equity.

lower

Under the pecking order theory, profitable firms will tend to have ______ levels of debt.

lower

In the real world, firms with high levels of investment in research and development will have ___.

lower target debt-equity ratios

Earnings surprises occur when earnings are ___.

lower than expected higher than expected

When ______-than-average returns today are likely to be followed by ______-than-average returns in the future, the coefficient of serial correlation will be positive indicating a tendency towards continuation.

lower; lower higher; higher

Protective covenants benefit shareholders by ____.

lowering interest rates on bonds increasing firm value

The less sensitive the value of an asset is to ____________ decisions, the more likely it is that the asset will be leased instead of purchased.

maintenance

According to survey evidence, a ______ of firms have target debt ratios.

majority

The main purpose of vertical acquisitions is to:

make coordination of closely related operating activities easier

If financial markets are inefficient, company managers should ____.

make foreign currency bets make interest rate bets

The information content of a dividend decrease may be that ___.

management believes future earnings will decline

Because managers are selected by the board of directors, which is elected by shareholders,we would expect that

managers always view things from the shareholders' perspective.

A bad reason for leasing is that leasing can be used to:

manipulate accounting numbers

Financial economists prefer the use of ______ values when measuring debt ratios.

market

Managers should worry about the ______ value of shares.

market

A combined firm may generate greater revenues than two separate firms because:

market power marketing gains strategic benefits

Ineffective media programming and advertising efforts can be improved by synergy. This is an example of a:

marketing gain

Increased revenues from a merger can come from;

marketing gains, strategic benefits and market power

Debt _____is the length of time the debt remains outstanding with some unpaid balance.

maturity

Registered bonds are ______ common than bearer bonds in the United States today.

maturity

Stockholders want to _____ the value of the entire firm.

maximize

From an investor's perspective, an optimal portfolio will ___.

maximize expected return and minimize risk

A company should select the capital structure that:

maximizes the company's value

When a start-up company receives venture capital, it in return:

may agree to let the venture capitalist appoint one or more members of senior management will give up a substantial portion of the company's equity to the venture capitalist will probably give several seats on the company's board of directors to the venture capitalist

Firms that issue high amounts of debt may also lease equipment frequently because the corporate attributes that provide high debt capacity:

may also make leasing advantageous

A firm facing bankruptcy may seek to join a financially sound firm. This is referred to as a(n):

merger

The absorption of one firm by another, where the acquiring firm retains its identity and the acquired firm ceases to exist as a separate firm is called a:

merger

Which of the following are ways a firm can be acquired:

merger, acquisition of stock, acquisition of assets

The avoidance of hold out ____________ shareholders is an advantage of acquiring another firm by purchasing its assets.

minority

Assets that fall above or below the security market line are:

mis-priced

Arbitrageurs attempt to make profit by trading ______ securities.

mispriced

Profitable firms will tend to have ______ debt than unprofitable firms.

more

The agency costs of equity makes debt financing _______ attractive.

more

The sales of cyclical firms are ______ sensitive to the business cycle than are the sales of non-cyclical firms.

more

The tax subsidy to debt has ______ value relative to other subsidies to debt financing.

more

Warrants are _____ valuable if stock prices are rising.

more

______ companies prefer the CAPM to the DDM.

more

The empirical evidence on actual stock return serial correlation coefficients indicates that they are ___.

near zero

When a higher-than-average return today is as likely to be followed by lower-than-average returns as higher-than-average returns, the coefficient of serial correlation will be ___.

near zero

A firm with excess free cash flow might take on a ______ NPV project instead of paying a dividend.

negative

A requirement in the bond indenture that the corporation cannot invest in highly speculative projects is an example of a(n) ______ covenant.

negative

A(n) _________ coefficient of serial correlation for a particular stock indicates a tendency towards reversal.

negative

Managers who are rewarded for the growth of their firm may be tempted to use extra cash on:

negative NPV projects

Common stockholders receive special preference in:

neither of these

The NPV of a lease is often called the:

net advantage of leasing

In theory, if there are personal taxes, a firm should ______ issue stock to pay dividends.

never

When should a firm give up a positive NPV project to pay a dividend?

never

According to efficient capital markets theory, stock prices will only react to ___.

new information

Systematic risk will ____ when securities are added to a portfolio.

no change

If markets are perfect, investors have ______ between a dividend and a stock repurchase.

no preference

According to the efficient markets hypothesis, the timing of a new equity issue is ______ important.

not

Manufacturing cash inflows will ______ due to the choice of leasing versus buying.

not change

If financial markets are efficient, company managers should ____.

not make interest rate bets not make foreign currency bets

According to the random walk theory, if the prices have been going up for the last 10 days, on the 11th day the prices will:

not necessarily go up

If investors purchase the stock of a firm that is engaged in a rights offering on the ex-rights date, they will:

not receive any rights when they are distributed

In Quiznos' bankruptcy agreement, stockholders received:

nothing

Because tax shields are important to the economic viability of a lease, interested parties should:

obtain an opinion from the IRS before signing a lease agreement

Before 1976, a firm did not have to include leases on its financial statements except in the footnotes. This accounting method was known as:

off-balance sheet financing

When Pete purchases $10,000 in stock by using $6,000 of his own money and borrowing the remaining $4,000 from his broker, he is buying stock ___.

on margin

A staggered election occurs when:

only a fraction of the board are elected at a time

The serial correlation of a stock's returns is different from the correlation between the returns of two different stocks because it ____.

only involves the returns of one stock

Given a choice, firms would classify all their leases as______ones

operating

Off-balance sheet financing makes firms with:

operating leases appear stronger than firms with identical capital leases

Start-up companies usually need OPM, which stands for:

other people's money

Rights offerings are quite common where:

outside of the US

In the graph at the right, security B is:

overpriced

Some of the agency costs generated by leases may include:

overuse of the asset misuse of the asset monitoring costs

A bidding manager is more likely to use stock to pay for a merger when they perceive their company is ______

overvalued

A bidding manager is more likely to use stock to pay for a merger when they perceive their company is _________

overvalued

The face value of a bond is also known as the ______ value of a bond

par

Weak form efficiency considers trading strategies that use information based solely on ______ stock prices.

past

preferred stock

pays a constant dividend pays dividends in perpetuity

In order to understand the effect of taxes on capital structure decisions, we need to consider both corporate and ______ taxes.

personal

The value of a levered firm in MM Proposition I with corporate taxes equals the value of an all-equity firm ___.

plus the tax rate times the value of debt

A firm should avoid cutting ______ NPV projects to pay dividends or buy back shares.

positive

A point above the SML line represents a project with a ______ NPV for an all-equity firm..

positive

Modigliani and Miller suggest that there is a(n) ______ relationship between leverage and firm value in the presence of corporate taxes.

positive

The historical market risk premium for equities has been ______.

positive

The requirement that a corporation must maintain a current ratio of 2.5 is an example of a(n) ______ covenant.

positive

The stock price reaction to dividend announcements is typically _______.

positive

There are no diversification benefits if there is perfect ______ correlation between two securities.

positive

Though studies may provide different estimates of the median premium to the target, all studies show that it is

positive

What is the likely inflation beta or the stock of a company that owns gold mines?

positive

When a firm announces an increase in debt, investors typically view this as:

positive

If βi is negative:

positive changes in the factor will decrease the ith stock's returns

If βi is positive:

positive changes in the factor will increase the ith stock's returns

What are the two types of protective covenants?

positive covenants negative covenants

If a stock tends to go up on news that inflation is exceeding expectations, it is ______ related to inflation.

positively

Under MM Proposition II, a firm's cost of equity capital is ______ related to the firm's debt-equity ratio provided the cost of capital for an all-equity firm exceeds the cost of debt.

positively

The expected return on equity is _____ to leverage.

positively related

A person with a high level of risk aversion would probably:

prefer leasing over buying

From a tax perspective, share repurchases are _______ to dividends.

preferred

In general, ______ shareholders do not have the right to vote.

preferred

-A red herring is another name for a _____.

preliminary prospectus

The difference between the expected return on the market portfolio and the risk-free rate is the market risk

premium

The equity risk_________is the additional return from bearing risk.

premium

The merger ______ is the difference between the acquisition price per share and the target's pre-acquisition share price, divided by the pre-acquisition share price.

premium

The return on market minus the risk-free rate is the market risk

premium

The return on market minus the risk-free rate is the market risk ________

premium

A combination of a completed private workout and a formal bankruptcy is a(n):

prepackaged bankruptcy

A negative covenant:

prohibits an activity by the corporation

A _________ covenant is an agreement between bondholders and stockholders

protective

Efficient markets ___.

provide fair rates of return provide fair prices

A written authorization for one shareholder to vote the stock of another shareholder is called a(n) ______.

proxy

When a group of shareholders attempts to gain control of a firm by soliciting votes from other stockholders, they are engaged in a:

proxy contest

When a group of stockholders solicit votes from other stockholders in an attempt to replace existing management it is called a:

proxy contest

Actively managed funds try to use ______ to beat the market.

publicly available information certain analytical skills price and volume patterns

If the net present value of the incremental cash flows from leasing relative to purchasing is negative, the firm will prefer to _______ the asset.

purchase

A negative NPV of leasing relative to purchasing would indicate that the:

purchase option should be taken

Other companies that specialize only in projects similar to the project your firm is considering are called ___

pure plays

The period of time before and after an IPO when communication with the public is limited is known as the ______ period.

quiet

If a firm issues stock to fund a project with a positive NPV, the stock price will:

raise

According to the __________ theory, the random component in any period is unrelated to random errors in any past period.

random walk

One explanation for stock splits is for companies to maintain a trading _______ to allow for round lot trading.

range

The preliminary prospectus, which contains much of the information found in the registration statement and is distributed to potential investors, is called a ___.

red herring

Cash dividends always ______ free cash flow.

reduce

Financial distress costs will ________ the value of the firm.

reduce

Long-term leases ______ taxes.

reduces

A leveraged buyout increases the value of the firm by:

reducing taxes

Leasing ______ risk because the lessee does not need to worry about residual value.

reduses

A vertical acquisition:

refers to a merger between firms at different steps of the production process

A document required by the SEC for new public issues that contains the issuing firm's financial information, financial history, and details of the existing business is known as the ____________.

registration statement

If the expected return of a project is below that of a financial asset of comparable risk, the firm should ______ the project.

reject

Dividends are ______ and/but dividend policy is ______.

relevant; irrelevant

Under MM with no taxes, as debt is ________ to capital structure, the cost of equity ______.

removed; decreases added; increases

Liquidation ends the firm's ongoing operations, but ______ includes the option of continuing of the business.

reorganization

Investors who jump into a hot market believing that the high returns will continue for an even longer period are said to exhibit ______.

representativeness

The investor trait of ______ occurs when investors draw conclusions from insufficient data.

representativeness

The proponents of efficient markets question whether the psychological traits of ______ will dominate in any given situation.

representativeness or conservatism

Rationality implies that investors, when faced with new information about a stock, will ___.

reprice the stock rationally

A project should only be accepted if its return is above what is ___.

required by investors

The CAPM can be used to estimate the _______.

required return on equity

The value of the asset at the end of a lease is referred to as the _____.

residual value

Managers who resist takeovers could be doing so because

resistance could induce the bidder to increase the offer

A sinking fund is used to:

retire debt

Dividends and capital gains given to the new shareholders represent ______ to the shareholders.

returns

The mean return and the standard deviation of returns can be used to describe the distribution of stock

returns

A negative coefficient of serial correlation for a particular stock indicates a tendency towards _________, which means a lower-than-average return today is likely to be followed by higher-than-average returns in the future.

reversal

The WACC should not be used for lease analysis because the cash flows do not have as much ______.

risk

The main functions of underwriters are to underwrite or manage _________.

risk

There is a difference in returns on small and large stocks, and most of that difference can be explained by differences in ___.

risk

Volatility or ______ increases for equity holders when leverage increases.

risk

Which of the following is a benefit of merging two companies who both have optimal debt levels?

risk reduction

With taxes, leverage creates a ______ tax shield.

risk-free

If the term of the lease is greater than 30 years, the transaction will be regarded as a conditional _______

sale

If the term of the lease is greater than 30 years, the transaction will be regarded as a conditional ________

sale

The most basic type of divestiture is the ______ of a division.

sale

A manufacturer supplies a ______ lease while an independent leasing company provides a ______ lease.

sales-type; direct

The firm's cost of equity capital is ______ the required rate of return to the shareholders.

same as

A new public offering from a firm that has previously issued securities is known as a(n):

seasoned equity offering

In a proxy contest, a group of shareholders attempts to gain __________ by soliciting proxies from other shareholders.

seats on the board of directors

Mortgage securities are:

secured by a mortgage on the real property of the borrower

According to the theory of efficient markets ___.

securities are efficiently priced at all times firms cannot easily fool the market

A firm may fool investors with a financing decision if they can:

sell a security for more than it is worth

Investment banks perform a variety of functions including:

selling securities acting as a broker facilitating mergers

A sale and leaseback occurs when a company:

sells an asset it owns then leases it back to retain the use of it

A market is said to be ______ form efficient if prices incorporate all publicly available information.

semistrong

The value of a share of stock should be equal to the present value of its future expected:

share repurchases dividend payments

Who elects the board of directors?

shareholders

An increase in the value of a previously all-equity firm occurs when debt is borrowed to repurchase stock because:

shareholders capture the interest tax shield

In bookbuilding,investors commit to buying a certain number of _______ various prices.

shares

Warrants entitle a bondholder to buy:

shares at a fixed price

The tendency to work less because of the incentive structure is called ______ behavior.

shirking behavior

The correct discount rate on a project ______ the expected return on a financial asset of comparable risk.

should be

APV is the preferred capital budgeting approach when there are:

side benefits to debt side costs to debt

For debt, book values and market values are typically:

similar

The ____ of the characteristic line of a stock's returns versus those of the market measures the stock's systematic risk.

slope beta

The Ibbotson SBBI data show that over the long-term, ___.

small-company stocks generated the highest average return small-company stocks had the highest risk level T-bills, which had the lowest risk, generated the lowest return

The behavioral view holds that ______ investors are irrational.

some

The assumption that independent deviations from rationality produce market efficiency implies that ____.

some investors may overreact to new stock price information some investors may underreact to new stock price information

When a firm makes a subsidiary into a separate entity, then distributes the shares in the entity to the parent company's stockholders it is called:

spin off

Stock ______ and stock dividends have essentially the same impacts on the corporation and the shareholder.

splits

The difference between the price an issuer receives and the offering price at which shares are sold to investors is known as:

spread

The standard deviation is the ______ of the variance.

square root

Stockholders appear to prefer dividend ______.

stability

An agreement that the acquirer will limit its holdings in the target is called a:

standstill agreement

Venture capital financing given to a firm within its first year of existence is referred to as:

start-up financing

A dividend can be in the form of cash or ______.

stock

Dilution of ___________ is unambiguously bad.

stock price

One of the main implications of efficiency is that managers should pay attention to how ______ react(s) to their announcements.

stock prices

A ____ causes the number of common shares outstanding to increase but leaves total owner's equity unchanged.

stock split

Some acquisitions promise ______ benefits, which are more like options than standard investment opportunities.

strategic

A vacuum cleaner company buying a computer chip company in hopes that it can develop a computer-driven vacuum is an example of which source of synergy?

strategic benefits

If you beat the market with inside information, you have violated the concept of ________ form efficiency.

strong

The evidence clearly does not support the existence of ______ form efficiency in the stock market.

strong

An operating lease's liability is hidden, making the balance sheet of a firm look:

stronger than a firm with an otherwise identical capital lease

A standby underwriting arrangement in conjunction with a rights offering gives the firm an alternative avenue of sale to ensure the ______ of the rights offering.

success

A change in the corporate charter increasing the required percentage of shareholder votes necessary to approve a merger is referred to as a:

super majority amendment

Earnings _______ occur when earnings are different than expected.

surprises

If the value of the combined firm after a merger is greater than the sum of its original parts individually, the merger has generated _______.

synergy

A(n) __________ repurchase occurs when a firm repurchases shares from specific individual stockholders.

targated

A firm that is being taken over by another firm is usually called a

target

Highly profitable firms are likely to have higher debt ratios because they can deduct interest for _____ purposes.

tax

One of the important reasons why firms choose to raise capital by issuing debt is because of the ______ benefits of debt.

tax

In a(n) ______ acquisition the shareholders of the acquired firm are considered to have sold their shares.

taxable

Depending on a person's marginal tax rate and timing, dividends can be tax disadvantaged relative to capital gains because dividends are:

taxed upon payment while capital gains taxes are deferred until the stock is sold

A(n) ______ offer is a public offer by one firm to buy the shares of another firm.

tender

A public offer to buy shares of a target firm is called a:

tender offer

When a firm announces to all of its stockholders that it is willing to buy a fixed number of shares at a specific price, it is referred to as a ___.

tender offer

When valuing a firm with the weighted average cost of capital, the ________ value of the firm can be estimated by assuming a constant perpetual growth rate for cash flows beyond the horizon.

terminal

The key to the prepackaged reorganization process is:

that both sides have something to gain and something to lose

The manager of a firm should change the capital structure if and only if ___.

the change will increase the value of the firm

The concept that stocks attract certain investors due to a firm's dividend policy and the resulting tax impact is called ___.

the clientele effect

In Chapter 11 bankruptcy,

the company usually remains in business

MM Proposition II shows that ___.

the cost of equity rises with leverage.

Liquidation occurs when ____________ directs the sale of all of the firm's assets.

the court

Throwing darts at the financial pages to construct a portfolio may not be a good strategy because:

the darts cannot consider the overall risk of the portfolio

The expression VAB- (VA + VB) measures:

the difference between the combined firm value and the sum of the values of the standalone firms possible synergies

If a tracking stock pays dividends, the size of the dividend depends on

the division's performance.

Formal bankruptcy may be preferential to equity holders because:

the firm can issue debtor in possession debt the firm can delay interest payments to prebankruptcy debt the lack of cash flow information favors equity holders

The firm's capital structure refers to:

the firm's mix of debt and equity

A beneficial rule to follow is to set the firm's capital structure so that ___.

the firm's value is maximized

When a firm declares a change in its dividend payout, the reaction in the market is called:

the information content effect

An increase in debt after a merger will have two effects to mitigate shareholder value loss, even without the prior action of debt retirement. They are:

the interest tax shield will raise firm value the increase in debt raises the probability of financial distress, so reduces the coinsurance effect

A company must file a registration statement with the SEC unless:

the issue is less than $5 million

FASB 13 states that a lease must be classified as a capital lease if:

the lease transfers ownership of the asset to the lessee at the end of the lease term the lease term is 75% or more of the estimated life of the asset

The unwillingness of many older, giant firms to cut dividends is referred to as ___.

the legacy effect

Who owns most of the firm after an LBO?

the managers

In the CAPM, beta represents the responsiveness of a security to the movements in ______ while in the APT, beta measures the responsiveness of a security's return to ______.

the market portfolio; a particular factor

Debtor in possession debt is:

the new senior debt a firm issue when it reorganizes

Reorganization bankruptcy allows management:

the option of keeping the firm a going concern

The Z-score developed by Edward Altman predicts:

the possibility of bankruptcy for a firm within one year

Under the FAS 13:

the present value of finance lease payments appears on the balance sheet

FASB 13 states that a lease must be classified as a capital lease if:

the present value of the lease payments are at least 75% of the fair market value of the asset at the beginning of the lease the present value of the lease payments are at least 90% of the fair market value of the asset the lessee can purchase the asset at a price below the fair market value at the end of the lease

Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?

the rate of inflation

The coinsurance effect says that mergers can help bondholders, and the size of the gain depends on:

the reduction in the probability of bankruptcy

Under MM Proposition II with no taxes, the WACC is invariant to the debt-equity ratio because ___.

the return on assets (Ro) is unchanged

According to the CAPM, what is the expected return on a stock if its beta is equal to zero?

the risk free rate

The risk free measure for the risk-free rate should be ______ the risk-free rate used for the market risk premium.

the same as

The comparison of the expected distress costs to the expected tax benefits of leverage is called:

the trade-off theory

If a corporation defaults on its bond issue, ______ represent(s) the bondholders.

the trustee

Not everyone believes in efficient markets because ___,

there are anomalies investors suffer illusions

Firms with volatile operating income tend to have lower debt ratios because ___.

there is a higher probability of experiencing financial distress

Operating leases do not appear on a firm's balance sheet, as such, however:

they must be reported elsewhere in the annual report, such as, the notes.

The main goal of a proxy fight is:

to replace the current management team

In bankruptcy liquidation, a bankruptcy trustee is elected by the creditors

to take over the assets of the debtor corporation

When an acquiring firm begins to buy the target's stock in secret it is referred to as a:

toehold

Most non financial companies issue ______ debt.

too little

If a firm uses its overall cost of capital to discount cash flows from higher risk projects, it will accept ______ projects.

too many high-risk

If a firm uses its overall cost of capital to discount cash flows from higher risk projects, it will reject ______ projects.

too many low-risk

A security issued to follow the performance of a specific division of a corporation is known as a ________ stock.

tracking

The difference between the lowest and highest prices at which a stock has traded is called its:

trading range

When a firm uses its cash to buy back shares of stock, the repurchased shares are held by the corporation and are accounted for as:

treasury stock

True or False: The correct discount rate on a project should be the expected return on a financial asset of comparable risk.

true

True or false: A line of credit from a bank sets the maximum amount that the bank is willing to lend to the business.

true

True or false: A portfolio return is a weighted average of the returns of individual securities in the portfolio.

true

True or false: According to CAPM, if the historical market risk premium is negative, we cannot justify a positive relationship between a security's expected return and its beta.

true

True or false: According to Fama and French, the percentage of companies paying dividends has fallen over the last few decades.

true

True or false: Arbitrage is more risky than it appears at first glance.

true

True or false: Expert witnesses are professionals that are used by the corporation and the bondholders to evaluate the fairness of the bankruptcy settlement.

true

True or false: In practice, economists use proxies for the market portfolio instead of the actual market portfolio.

true

True or false: It is possible for the present value of distress costs to exceed the present value of tax savings.

true

True or false: It is possible for the unsystematic risk of a portfolio to be reduced to practically zero.

true

True or false: Nonpayment of periodic interest on debt can lead to bankruptcy.

true

True or false: Other companies that specialize only in projects similar to the project your firm is considering are called pure plays.

true

True or false: Some firms may have more than one class of common stock.

true

True or false: Target managers may be skeptical of a takeover because they want to keep their job following an acquisition.

true

True or false: Tax effects can explain why both manufacturers and third-party lessors offer leases.

true

True or false: The dividend discount model for a stock can be generalized to the market as a whole.

true

True or false: The purchase price is compared to the reduction in the optimal debt level when leasing.

true

True or false: The rate of return required by shareholders is the same as the firm's cost of equity capital.

true

The ______ ensures that the terms of a bond indenture are obeyed.

trustee

If beta is equal to zero, stock returns are ______ by the factor F in a factor model.

unaffected

Under MM Proposition II with no taxes, the return on assets ______ as debt increases.

unchanged

The overwhelming evidence on mutual funds is that, on average, they:

underperform broad-based indexes

On average, all mutual funds ______ the market by approximately ______ percent per year.

underperform; 2

IPO_____helps to mitigate an underwriter being sued by angry investors for selling overpriced securities.

underpricing

That the average IPO price tends to rise on the first day of trading following issuance is called .

underpricing

Dividend smoothing contends that when a firm evaluates an increase in cash flow it ___.

understands that only part of the change will be permanent

The gross spread is also referred to as the ______ discount.

underwriting

Systematic risk and unsystematic risk make up the:

unexpected return

Arrearage refers to:

unpaid dividends on preferred stock

An initial public offering (IPO) is also referred to as a(n) ___.

unseasoned new issue

In the US, debentures are _______ debt; in the UK, debentures are ________ debt.

unsecured; secured

In a large portfolio,------------, Incorrect Unavailable risk is diversified away.

unsystematic

The two sources of risk for a stock are systematic risk and ______ risk.

unsystematic

Another name for idiosyncratic risk is ______ risk.

unsystematic diversifiable

Rationality implies that investors will ___.

use new information to estimate stock prices use current information as well as new information to estimate stock prices

To estimate the dividend yield of a particular stock, we can ___.

use security analysts' forecasts multiply last year's dividend by (1 + g)

Dilution of the ownership of existing shareholders can be avoided by:

using a rights offering

The transactions costs for leasing compared to buying are:

usually lower for leasing

The weighted average cost of capital (RWACC) is the overall expected return the firm must earn on its existing assets to maintain its ___.

value

The acquisition of a firm at a different step of the production process is called a:

vertical acquisition

The DuPont-Conoco merger was mainly motivated because it allowed for what?

vertical integration

Money managers that specialize in the securities of distress companies are known as _________.

vultures

A leveraged buyout reduces large cash flows and forces management to curb ______.

waste

A serial correlation coefficient near zero would support ______ form market efficiency.

weak

Which of the following have empirical support?

weak semistrong

Pt = Pt - 1 + Expected return + Random errort represents:

weak form efficiency

The beta of the portfolio is a ______ average of the betas of the individual items in the portfolio.

weighted

One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future:

when economic conditions change quickly

A third party who is invited to make a significant investment in the firm under the condition that it votes with management and doesn't acquire additional shares is a:

white squire

The two components of capital are fixed capital and ______ capital.

working

If there is significant serial correlation, stock markets ______ be weak-form efficient.

would not

A dividend _______ is the amount of the dividend expressed as a percentage of the stock's market price,

yield

ABC has a beta of 2.5 and XYZ has a beta of 1.5. The risk-free rate is 4 percent and the market risk premium is 9 percent. What is the expected return on a portfolio that is equally invested in ABC and XYZ?

βP = (2.5 + 1.5)/2 = 2 Expected return = 4% + 2(9%) = 22%