Corporate Finance Chp 13-15

Which one of the following statements concerning dilution is correct?

Market value dilution occurs when the net present value of a project is negative

Which one of the following statements is correct?

Over time, the average unexpected return will be zero.

Which one of the following indicates a portfolio is being effectively diversified?

a decrease in the portfolio standard deviation

What is a prospectus?

a document that describes the details of a proposed security offering along with relevant information about the issuer

Which one of the following is the best example of a diversifiable risk?

a firm's sales decrease

What is the definition of a syndicate?

a group of underwriters sharing the risk of selling a new issue of securities

A stock with an actual return that lies above the security market line has:

a higher return than expected for the level of risk assumed.

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

reward-to-risk ratio

Which one of the following statements is correct?

A TV interview with a firm's CFO could cause a forced delay in the firm's IPO

Which one of the following statements is correct concerning a portfolio beta?

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.

Which one of the following statements is correct?

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

Which one of the following statements is correct concerning the issuance of long-term debt?

Direct placement debt tends to have more restrictive covenants than publicly issued debt

Which one of the following statements is correct concerning unsystematic risk?

Eliminating unsystematic risk is the responsibility of the individual investor.

Which one of the following statements concerning venture capitalists is correct?

Exit strategy is a key consideration when selecting a venture capitalist

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.

The model is dependent upon a reliable estimate of the market risk premium.

With Dutch auction underwriting:

all successful bidders pay the same price

Flotation costs for a levered firm should:

be weighted and included in the initial cash flow.

The total direct costs of underwriting an equity IPO:

can be as high as 25 percent for small issues

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

When a firm announces an upcoming seasoned stock offering, the market price of the firm's existing shares tends to:

decrease

A firm's cost of capital:

depends upon how the funds raised are going to be spent.

Roy owns 200 shares of R.T.F., Inc. He has opted not to participate in the current rights offering by this firm. As a result, Roy will most likely be subject to:

dilution

What is an issue of securities that is offered for sale to the general public on a direct cash basis called?

general cash offer

Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is issuing additional shares of stock and that he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called?

rights offer

The intercept point of the security market line is the rate of return which corresponds to:

the risk-free rate.

The discount rate assigned to an individual project should be based on:

the risks associated with the use of the funds required by the project.

The flotation cost for a firm is computed as:

the weighted average of the flotation costs associated with each form of financing.

Standard deviation measures which type of risk?

total

Shelf registration allows a firm to register multiple issues at one time with the SEC and then sell those registered shares anytime during the subsequent:

2 years

How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio?

25

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

Expected Return

Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?

Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

Denver Liquid Wholesalers recently offered 50,000 new shares of stock for sale. The underwriters sold a total of 53,000 shares to the public. The additional 3,000 shares were purchased in accordance with which one of the following?

Green shoe provision

Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV. toymakers are required to improve their safety standards

I and IV only

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II and III only

The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio.

I, II, III, and IV

Which of the following have been offered as supporting arguments in favor of IPO underpricing? I. Underpricing counteracts the "winner's curse". II. Underpricing rewards institutional investors for sharing their opinions of a stock's market value. III. Underpricing diminishes the underwriting risk of a firm commitment underwriting. IV. Underpricing reduces the probability that investors will sue the underwriters.

I, II, III, and IV

Which of the following should be considered when selecting a venture capitalist? I. level of involvement II. past experiences III. termination of funding IV. financial strength

I, II, III, and IV

The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.

I, II, and III only

The value of a right depends upon: I. the number of rights required to purchase one new share. II. the market price of the security. III. the subscription price. IV. the price-earnings ratio of the stock

I, II, and III only

The capital asset pricing model (CAPM) assumes which of the following? I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the reward-to-risk ratio is constant. IV. the market rate of return can be approximated.

I, III, and IV only

The aftertax cost of debt generally increases when: I. a firm's bond rating increases. II. the market rate of interest increases. III. tax rates decrease. IV. bond prices rise.

II and III only

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II and IV only

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend

II, III, and IV only

Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant

II, III, and IV only

Which one of the following statements is correct?

Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

Which one of the following statements related to risk is correct?

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio

Which one of the following statements is correct concerning the costs of issuing securities?

There tends to be substantial economies of scale when issuing securities

Which one of the following events would be included in the expected return on Sussex stock?

This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.

Which one of the following statements related to unexpected returns is correct?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

Which one of the following statements concerning venture capital financing is correct?

Venture capitalists often require at least a forty percent equity position as a condition of financing

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

a reduction in the risk-free rate

An individual investor with a small portfolio who wishes to purchase 100 shares of each IPO is more likely to receive an allocation of shares when:

an IPO is undersubscribed

The capital structure weights used in computing the weighted average cost of capital:

are based on the market value of the firm's debt and equity securities.

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:

assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

The subjective approach to project analysis:

assigns discount rates to projects based on the discretion of the senior managers of a firm.

Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walkin deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?

both Phil's and Theresa's

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio.

The standard deviation of a portfolio:

can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

capital asset pricing model

Which one of the following is an example of unsystematic risk?

consumer spending on entertainment decreased nationally

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

cost of capital.

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:

cost of debt

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?

cost of equity

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

either stock A is overpriced or stock B is underpriced or both.

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk

D.L. Jones & Co. recently went public. The firm received $20.80 a share on the entire offer of 25,000 shares. Keeser & Co. served as the underwriter and sold 23,700 shares to the public at an offer price of $22 a share. What type of underwriting was this?

firm commitment

Trevor is the CEO of Harvest Foods, which is a privately-held corporation. What is the first step he must take if he wishes to take Harvest Foods public?

gain board approval

The difference between the underwriters' cost of buying shares in a firm commitment and the offering price of those securities to the public is called the:

gross spread

The aftertax cost of debt:

has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

A firm's overall cost of equity is:

highly dependent upon the growth rate and risk level of the firm.

The date on which a shareholder is officially listed as the recipient of stock rights is called the:

holder-of-record date

The cost of equity for a firm:

ignores the firm's risks when that cost is based on the dividend growth model.

Incorporating flotation costs into the analysis of a project will:

increase the initial cash outflow of the project

When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:

increase the initial project cost by dividing that cost by (1 - 0.07).

Soup Galore is a partnership that was formed three years ago for the purpose of creating, producing, and distributing healthy soups in a dried form. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called?

initial public offering

Which one of the following is an example of systematic risk?

investors panic causing security prices around the globe to fall precipitously

With firm commitment underwriting, the issuing firm:

knows up-front the amount of money it will receive from the stock offering

Which one of the following is represented by the slope of the security market line?

market risk premium

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock.

If a stock portfolio is well diversified, then the portfolio variance:

may be less than the variance of the least risky stock in the portfolio.

Assigning discount rates to individual projects based on the risk level of each project:

may cause the firm's overall weighted average cost of capital to either increase or decrease over time.

Existing shareholders:

may or may not have a preemptive right to newly issued shares

Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for ten years. Which firm(s), if either, should accept this project?

neither Company A or Company B

Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?

neither Wilderness Adventures nor Travel Excitement

Franklin Minerals recently had a rights offering of 1,000 shares at an offer price of $10 a share. Isabelle is a shareholder who exercised her rights option by buying all of the rights to which she was entitled based on the number of shares she owns. Currently, there are six shareholders who have opted not to participate in the rights offering. Isabelle would like to purchase the unsubscribed shares. Which one of the following will allow her to do so?

oversubscription privilege

Before a seasoned stock offering, you owned 7,500 shares of a firm that had 500,000 shares outstanding. After the seasoned offering, you still owned 7,500 shares but the number of shares outstanding rose to 625,000. Which one of the following terms best describes this situation?

percentage ownership dilution

Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments?

portfolio

Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following?

portfolio weight

Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:

prefer higher risk projects over lower risk projects.

Which one of the following is a key goal of the aftermarket period?

price support for a new issue of securities

A group of five private investors recently loaned $6 million to Henderson Hardware for ten years at 9 percent interest. This loan is best described as a:

private placement

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.

pure play

The 40-day period following an IPO during which the SEC places restrictions on the public communications of the issuer is known as the _____ period.

quiet

The weighted average cost of capital for a firm is the:

rate of return a firm must earn on its existing assets to maintain the current value of its stock.

Underwriters generally:

receive less compensation under a competitive agreement than under a negotiated agreement

Which one of the following is a preliminary prospectus?

red herring

Which one of the following is least apt to reduce the unsystematic risk of a portfolio?

reducing the number of stocks held in the portfolio

What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public?

registration statement

The cost of preferred stock is computed the same as the:

return on a perpetuity.

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly

risk premium

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium.

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate.

What is a seasoned equity offering?

sale of newly issued equity shares by a firm that is currently publicly owned

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

security market line

Suzie is a chemist who has been experimenting with fragrances in her home laboratory and feels that she now has three viable perfumes that could be successfully marketed. She knows a venture capitalist who has offered to finance her business to the point where she would be ready to begin the manufacturing and marketing stage. Which type of financing is Suzie being offered?

seed money

Pearson Electric recently registered 250,000 shares of stock under SEC Rule 415. The firm plans to sell 150,000 shares this year and the remaining 100,000 shares next year. What type of registration was this?

shelf registration

The principle of diversification tells us that:

spreading an investment across many diverse assets will eliminate some of the total risk.

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

A rights offering in which an underwriting syndicate agrees to purchase the unsubscribed portion of an issue is called a _____ underwriting.

standby

The amount paid to an underwriter who participates in a standby underwriting agreement is called a(n):

standby fee

Which one of the following should earn the most risk premium based on CAPM?

stock with a beta of 1.38

To purchase shares in a rights offering, a shareholder generally just needs to:

submit the required number of rights along with the subscription price

The market risk premium is computed by:

subtracting the risk-free rate of return from the market rate of return

Which one of the following is a risk that applies to most securities?

systematic

Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called

tombstones

Executive Tours has decided to take its firm public and has hired an investment firm to handle this offering. The investment firm is serving as a(n):

underwriter

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?

unsystematic

Which one of the following risks is irrelevant to a well-diversified investor?

unsystematic risk

Which one of the following is the primary determinant of a firm's cost of capital?

use of the funds

Jones & Co. is funded by a group of individual investors for the sole purpose of providing funding for individuals who are trying to convert their new ideas into viable products. What is this type of funding called?

venture capital

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:

weighted average cost of capital.

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state.

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

will plot to the right of the overall market on a security market line graph.

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time.

I, II, III, and IV

The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy

I, II, III, and IV

Which one of the following statements is correct for a firm that uses debt in its capital structure?

The WACC should decrease as the firm's debt-equity ratio increases.

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?

The firm's cost of equity is unaffected by a change in the firm's tax rate

The systematic risk of the market is measured by:

a beta of 1.0.

The expected return on a stock computed using economic probabilities is:

a mathematical expectation based on a weighted average and not an actual anticipated outcome.

Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares. Which one of the following terms best describes this underwriting?

best efforts

Systematic risk is measured by:

beta

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?

beta

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

beta of the security and the market rate of return.

Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity?

by using the capital asset pricing model

Shares of PLS United have been selling with rights attached. Tomorrow, the stock will sell independent of these rights. Which one of the following terms applies to tomorrow in relation to this stock?

ex-rights date

Which one of the following is most directly affected by the level of systematic risk in a security?

expected rate of return

The pre-tax cost of debt:

is based on the current yield to maturity of the firm's outstanding bonds.

The Securities and Exchange Commission:

is concerned only that an issue complies with all rules and regulations

The cost of preferred stock:

is equal to the dividend yield.

The dividend growth model:

is only as reliable as the estimated rate of growth

The weighted average cost of capital for a wholesaler:

is the return investors require on the total assets of the firm

If an IPO is underpriced then the:

issuing firm receives less money than it probably should have

Which one of the following is probably the most successful means of finding venture capital?

personal contacts

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

systematic risk principle

Direct business loans typically ranging from one to five years are called:

term loans