Corporate Finance final
What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average? A. 1.0 percent B. 2.5 percent C. 5.0 percent D. 16 percent E. 32 percent
16 percent
Which one of the following time periods is associated with high rates of inflation? A. 1929-1933 B. 1957-1961 C. 1978-1981 D. 1992-1996 E. 2001-2005
1978-1981
The average annual return on small-company stocks was about _____ percent greater than the average annual return on large-company stocks over the period 1926-2010. A. 3 B. 5 C. 7 D. 9 E. 11
5
According to Jeremy Siegel, the real return on stocks over the long-term has averaged about: A. 6.7 percent B. 8.7 percent C. 10.4 percent D. 12.3 percent E. 14.8 percent
6.7 percent
Of the following new product expansion situations, only one would not result in incremental cash flows so it should not be included in the capital budgeting analysis. Which situation is it?
A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.
Which one of the following statements is correct concerning market efficiency? A. Real asset markets are more efficient than financial markets. B. If a market is efficient, arbitrage opportunities should be common. C. In an efficient market, some market participants will have an advantage over others. D. A firm will generally receive a fair price when it issues new shares of stock. E. New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock.
A firm will generally receive a fair price when it issues new shares of stock.
Which one of the following statements best defines the efficient market hypothesis? A. Efficient markets limit competition. B. Security prices in efficient markets remain steady as new information becomes available. C. Mispriced securities are common in efficient markets. D. All securities in an efficient market are zero net present value investments. E. Profits are removed as a market incentive when markets become efficient.
All securities in an efficient market are zero net present value investments.
Which one of the following statements related to capital gains is correct? A. The capital gains yield includes only realized capital gains. B. An increase in an unrealized capital gain will increase the capital gains yield. C. The capital gains yield must be either positive or equal to zero. D. The capital gains yield is expressed as a percentage of the sales price. E. The capital gains yield represents the total return earned by an investor.
An increase in an unrealized capital gain will increase the capital gains yield.
International Advertising Services has two projects that are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and Project B's IRR is 20%. International's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?
Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
WACC formula
Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 - Tax Rate) + Cost of Preferred * (% Preferred)
Finding cashflows using EBIT
EBIT-taxes= cash flows
If a firm has zero cost of capital and two mutually exclusive projects, the payback method and NPV method would always lead to the same decision on which project to undertake. True False
F
If a project would lead to an increase a firm's cost of capital (its' WACC), it should not be accepted. True False
F
In general, the value of land currently owned by a firm is irrelevant to a capital budgeting decision because the cost of that property is a sunk cost. True False
F
Other things held constant, a decrease in the cost of capital (discount rate) will cause an increase in a project's IRR. True False
F
Projects with nonnormal cash flows sometimes have multiple MIRRs. True False
F
The NPV and MIRR methods lead to the same decision for mutually exclusive projects regardless of the projects' relative sizes. True False
F
Which of the following statements is correct in relation to a stock investment? I. The capital gains yield can be positive, negative, or zero. II. The dividend yield can be positive, negative, or zero. III. The total return can be positive, negative, or zero. IV. Neither the dividend yield nor the total return can be negative. A. I only B. I and II only C. I and III only D. I and IV only E. IV only
I and III only
Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient. A. I and III only B. II and IV only C. I and IV only D. I, III, and IV only E. I, II, and III only
I, II, and III only
If the variability of the returns on large-company stocks were to increase over the long-term, you would expect which of the following to occur as a result? I. decrease in the average rate of return II. increase in the risk premium III. increase in the 68 percent probability range of the frequency distribution of returns IV. decrease in the standard deviation A. I only B. IV only C. II and III only D. I and III only E. II and IV only
II and III only
Which of the following correspond to a wide frequency distribution? I. relatively low risk II. relatively low rate of return III. relatively high standard deviation IV. relatively large risk premium A. II only B. III only C. I and II only D. II and III only E. III and IV only
III and IV only
Which two of the following are the most likely reasons why a stock price might not react at all on the day that new information related to the stock issuer is released? I. insiders knew the information prior to the announcement II. investors need time to digest the information prior to reacting III. the information has no bearing on the value of the firm IV. the information was anticipated A. I and II only B. I and III only C. II and III only D. II and IV only E. III and IV only
III and IV only
IRR Decision Rule
IRR > required rate return, accept IRR < required rate return, reject
Which of the following statements are true based on the historical record for 1926-2010? I. Risk and potential reward are inversely related. II. Risk-free securities produce a positive real rate of return each year. III. Returns are more predictable over the short-term than they are over the long-term. IV. Bonds are generally a safer investment than are stocks. A. I only B. IV only C. II and III only D. II and IV only E. II, III, and IV only
IV only
Which of the following statements is correct?
If a project has an NPV greater than zero, then taking on the project will increase the value of the firm's stock.
Assuming that a project being considered has normal cash flows, with one outflow followed by a series of inflows, which of the following statements is CORRECT?
If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.
Which of the following statements about capital budgeting is CORRECT?
If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net proceeds that could be obtained should be charged as a cost to the project under consideration.
NPV Decision Rule
If the computed NPV is greater than zero, accept.
Mountaineer Manufacturing is considering two normal, equally risky, mutually exclusive, but not repeatable projects. The two projects have the same investment costs, but Project A has an IRR of 15%, while Project B has an IRR of 20%. Mountaineer has a WACC of 10%. Assuming the projects’ NPV profiles cross in the upper right quadrant, which of the following statements is CORRECT?
If the crossover rate is 8%, Project B will have the higher NPV.
Global Spice Co. is considering a new project, but all methods for assessing risk indicate that the project's risk is greater than the risk of the firm's average project. In evaluating this project, it would be reasonable for Global Spice's management to do which of the following?
Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.
In capital budgeting decisions, corporate risk will be of least interest to:
Institutional investors.
The historical record for the period 1926-2010 supports which one of the following statements? A. A higher-risk security will provide a higher rate of return next year than will a lower-risk security. B. If you need a stated amount of money next year, your best investment option today for those funds would be long-term government bonds. C. Increased long-run potential returns are obtained by lowering risks. D. It is possible for small-company stocks to more than double in value in any one given year. E. Inflation was positive each year throughout the period of 1926-2010.
It is possible for small-company stocks to more than double in value in any one given year.
Which one of the following statements is correct based on the historical record for the period 1926-2010? A. The standard deviation of returns for small-company stocks was double that of large-company stocks. B. U.S. Treasury bills had a zero standard deviation of returns because they are considered to be risk-free. C. Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds. D. Inflation was less volatile than the returns on U.S. Treasury bills. E. Long-term government bonds underperformed intermediate-term government bonds.
Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds.
Which of the following statements about IRR and WACC is CORRECT?
Multiple IRRs can only occur if the signs of the cash flows change more than once.
calculating Modified Rate of Return
Positive cash flows x the cost of capital ÷ by the initial outlays x the financing cost.
A company's new project evaluation should include all of the following EXCEPT:
Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.
Finding EBIT using Revenue
Revenue-operating cost=EBIT
Which of the following statements about sensitivity analysis and simulation analysis is CORRECT?
Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.
Which of the following statements about risk evaluation is CORRECT?
Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.
Among the conditions that may cause a project to have more than one IRR, one might be the situation in which a negative cash flow (or cost) occurs at the end of the project's life in addition to the initial investment at time = 0. True False
T
Assume that a project has one initial cash outflow followed by a series of positive cash inflows. To use the modified IRR (MIRR) method, you would compound the cash inflows out to the end of the project's life, sum those compounded cash flows to form a terminal value (TV), and then find the discount rate that causes the PV of the TV to equal the project's cost.
T
In general, small businesses use DCF capital budgeting techniques less often than large businesses do. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for very small firms. True False
T
In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. Managers' tastes, choice of accounting method, or the profitability of other independent projects should not be considered. True False
T
McDonald's is planning to open a new store across from the student union. Annual revenues are expected to be $5 million. However, opening the new location will cause annual revenues to drop by $3 million at McDonald's existing stadium location. The relevant sales revenues for the capital budgeting analysis are $2 million per year. True False
T
The IRR method can be used in place of the NPV method for all independent projects. True False
T
The NPV method is preferred over the IRR method because the NPV method's reinvestment rate assumption is better. True False
T
Which of the following statements about IRR and NPV is CORRECT?
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
The CFO of Rambler Retail Concepts is considering a new project, so she plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?
The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life.
Which one of the following statements concerning U.S. Treasury bills is correct for the period 1926- 2010? A. The annual rate of return always exceeded the annual inflation rate. B. The average risk premium was 0.7 percent. C. The annual rate of return was always positive. D. The average excess return was 1.1 percent. E. The average real rate of return was zero.
The annual rate of return was always positive.
Which one of the following best defines the variance of an investment's annual returns over a number of years? A. The average squared difference between the arithmetic and the geometric average annual returns. B. The squared summation of the differences between the actual returns and the average geometric return. C. The average difference between the annual returns and the average return for the period. D. The difference between the arithmetic average and the geometric average return for the period. E. The average squared difference between the actual returns and the arithmetic average return.
The average squared difference between the actual returns and the arithmetic average return.
Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $0.75 in dividends. Which one of the following statements is correct in relation to this investment? A. The dividend yield is expressed as a percentage of the selling price. B. The capital gain would have been less had Stacy not received the dividends. C. The total dollar return per share is $3. D. The capital gains yield is positive. E. The dividend yield is greater than the capital gains yield.
The capital gains yield is positive.
Which one of the following statements is correct? A. The greater the volatility of returns, the greater the risk premium. B. The lower the volatility of returns, the greater the risk premium. C. The lower the average return, the greater the risk premium. D. The risk premium is unrelated to the average rate of return. E. The risk premium is not affected by the volatility of returns.
The greater the volatility of returns, the greater the risk premium.
WACC indicating NPV
The higher the WACC the lower the NPV
If a project being considered has normal cash flows, with one outflow followed by a series of inflows, which of the following statements is CORRECT?
The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
A project is described as having normal cash flows, meaning one outflow followed by a series of inflows. Which of the following statements about normal cash flows is CORRECT?
To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
NPV formula
Total Present Value - Investment
Which one of the following categories of securities had the lowest average risk premium for the period 1926-2010? A. long-term government bonds B. small company stocks C. large company stocks D. long-term corporate bonds E. U.S. Treasury bills
U.S. Treasury bills
Which one of the following was the least volatile over the period of 1926-2010? A. large-company stocks B. inflation C. long-term corporate bonds D. U.S. Treasury bills E. intermediate-term government bonds
U.S. Treasury bills
Which one of the following statements correctly applies to the period 1926-2010? A. Large-company stocks earned a higher average risk premium than did small-company stocks. B. Intermediate-term government bonds had a higher average return than long-term corporate bonds. C. Large-company stocks had an average annual return of 14.7 percent. D. Inflation averaged 2.6 percent for the period. E. U.S. Treasury bills had a positive average real rate of return.
U.S. Treasury bills had a positive average real rate of return.
Which one of the following statements is a correct reflection of the U.S. markets for the period 1926-2010? A. U.S. Treasury bill returns never exceeded a 9 percent return in any one year during the period. B. U.S. Treasury bills provided a positive rate of return each and every year during the period. C. Inflation equaled or exceeded the return on U.S. Treasury bills every year during the period. D. Long-term government bonds outperformed U.S. Treasury bills every year during the period. E. National deflation occurred at least once every decade during the period.
U.S. Treasury bills provided a positive rate of return each and every year during the period.
non-conventional cashflows
a project with multiple cashflows , use MIRR to calculate
conventional cashflows
a project with one cashflow , use IRR to calculate
graphing the WACC
a projects NPV must intersect the c axis at the project's WACC
The return earned in an average year over a multi-year period is called the _____ average return. A. arithmetic B. standard C. variant D. geometric E. real
arithmetic
NPV method
assumes that the cashflows are reinvested at the WACC rate (cost of capital)
Assume that you invest in a portfolio of large-company stocks. Further assume that the portfolio will earn a rate of return similar to the average return on large-company stocks for the period 1926-2010. What rate of return should you expect to earn? A. less than 10 percent B. between 10 and 12.5 percent C. between 12.5 and 15 percent D. between 15 and 17.5 percent E. more than 17.5 percent
between 10 and 12.5 percent
What was the highest annual rate of inflation during the period 1926-2010? A. between 0 and 3 percent B. between 3 and 5 percent C. between 5 and 10 percent D. between 10 and 15 percent E. between 15 and 20 percent
between 10 and 15 percent
What was the average rate of inflation over the period of 1926-2010? A. less than 2.0 percent B. between 2.0 and 2.5 percent C. between 2.5 and 3.0 percent D. between 3.0 and 3.5 percent E. greater than 3.5 percent
between 3.0 and 3.5 percent
Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share to $1.50 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price: A. was unaffected by the announcement. B. increased proportionately with the dividend decrease. C. decreased proportionately with the dividend decrease. D. decreased by $0.14 per share. E. increased by $0.14 per share.
decreased proportionately with the dividend decrease.
Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. Which one of the following terms best defines that market? A. riskless market B. evenly distributed market C. zero volatility market D. Blume's market E. efficient capital market
efficient capital market
Operating costs includes...
fixed costs and variable costs
The average compound return earned per year over a multi-year period is called the _____ average return. A. arithmetic B. standard C. variant D. geometric E. real
geometric
Accepting a project using NPV
if you have a project and accept it using NPV you must also accept it using IRR and PI
To convince investors to accept greater volatility, you must: A. decrease the risk premium. B. increase the risk premium. C. decrease the real return. D. decrease the risk-free rate. E. increase the risk-free rate.
increase the risk premium.
According to theory, studying historical stock price movements to identify mispriced stocks: A. is effective as long as the market is only semistrong form efficient. B. is effective provided the market is only weak form efficient. C. is ineffective even when the market is only weak form efficient. D. becomes ineffective as soon as the market gains semistrong form efficiency. E. is ineffective only in strong form efficient markets.
is ineffective even when the market is only weak form efficient.
As long as the inflation rate is positive, the real rate of return on a security will be ____ the nominal rate of return. A. greater than B. equal to C. less than D. greater than or equal to E. unrelated to
less than
Individuals who continually monitor the financial markets seeking mispriced securities: A. earn excess profits over the long-term. B. make the markets increasingly more efficient. C. are never able to find a security that is temporarily mispriced. D. are overwhelmingly successful in earning abnormal profits. E. are always quite successful using only historical price information as their basis of evaluation.
make the markets increasingly more efficient.
The real rate of return on a stock is approximately equal to the nominal rate of return: A. multiplied by (1 + inflation rate). B. plus the inflation rate. C. minus the inflation rate. D. divided by (1 + inflation rate). E. divided by (1 - inflation rate).
minus the inflation rate.
Which one of the following correctly describes the dividend yield? A. next year's annual dividend divided by today's stock price B. this year's annual dividend divided by today's stock price C. this year's annual dividend divided by next year's expected stock price D. next year's annual dividend divided by this year's annual dividend E. the increase in next year's dividend over this year's dividend divided by this year's dividend
next year's annual dividend divided by today's stock price
Which one of the following is defined by its mean and its standard deviation? A. arithmetic nominal return B. geometric real return C. normal distribution D. variance E. risk premium
normal distribution
Estimates of the rate of return on a security based on a historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term. A. overestimate; overestimate B. overestimate; underestimate C. underestimate; overestimate D. underestimate; underestimate E. accurately; accurately
overestimate; underestimate
The primary purpose of Blume's formula is to: A. compute an accurate historical rate of return. B. determine a stock's true current value. C. consider compounding when estimating a rate of return. D. determine the actual real rate of return. E. project future rates of return.
project future rates of return.
Compute Profitability Index
pv of cash flows/ initial investment
IRR0
reinvested at the IRR rate
The excess return is computed as the: A. return on a security minus the inflation rate. B. return on a risky security minus the risk-free rate. C. risk premium on a risky security minus the risk-free rate. D. the risk-free rate plus the inflation rate. E. risk-free rate minus the inflation rate.
return on a risky security minus the risk-free rate.
Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return? A. risk premium B. geometric return C. arithmetic D. standard deviation E. variance
risk premium
You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect
semistrong
Which one of the following categories of securities had the highest average return for the period 1926-2010? A. U.S. Treasury bills B. large company stocks C. small company stocks D. long-term corporate bonds E. long-term government bonds
small company stocks
Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2010? Rank from highest to lowest. A. large company stocks, U.S. Treasury bills, long-term government bonds B. small company stocks, long-term corporate bonds, large company stocks C. small company stocks, long-term corporate bonds, intermediate-term government bonds D. large company stocks, small company stocks, long-term government bonds E. intermediate-term government bonds, long-term corporate bonds, U.S. Treasury bills
small company stocks, long-term corporate bonds, intermediate-term government bonds
Which one of the following categories of securities has had the most volatile returns over the period 1926-2010? A. long-term corporate bonds B. large-company stocks C. intermediate-term government bonds D. U.S. Treasury bills E. small-company stocks
small-company stocks
Which one of the following earned the highest risk premium over the period 1926-2010? A. long-term corporate bonds B. U.S. Treasury bills C. small-company stocks D. large-company stocks E. long-term government bonds
small-company stocks
Small-company stocks, as the term is used in the textbook, are best defined as the: A. 500 newest corporations in the U.S. B. firms whose stock trades OTC. C. smallest twenty percent of the firms listed on the NYSE. D. smallest twenty-five percent of the firms listed on NASDAQ. E. firms whose stock is listed on NASDAQ.
smallest twenty percent of the firms listed on the NYSE.
The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect
strong
nside information has the least value when financial markets are: A. weak form efficient. B. semiweak form efficient. C. semistrong form efficient. D. strong form efficient. E. inefficient.
strong form efficient.
wacc decision rule
the lower the wacc the higher the market value of a company
Efficient financial markets fluctuate continuously because: A. the markets are continually reacting to old information as that information is absorbed. B. the markets are continually reacting to new information. C. arbitrage trading is limited. D. current trading systems require human intervention. E. investments produce varying levels of net present values.
the markets are continually reacting to new information.
calculate discount payback period
the year before full recovery+(uncovered cash flows/ cash flow in the year of full recovery)
Standard deviation is a measure of which one of the following? A. average rate of return B. volatility C. probability D. risk premium E. real returns
volatility
If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace. A. weak B. semiweak C. semistrong D. strong E. perfect
weak
A multiple IRR problem occurs when
you have multiple changes in your cashflows
Which one of the following is most indicative of a totally efficient stock market? A. extraordinary returns earned on a routine basis B. positive net present values on stock investments over the long-term C. zero net present values for all stock investments D. arbitrage opportunities which develop on a routine basis E. realizing negative returns on a routine basis
zero net present values for all stock investments