Fina 5311 Exam

The length of time a firm must wait to recoup the money it has invested in a project is called the:

payback period

Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n):

portfolio weight

The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.

positive

If the tax rate increases, the value of the depreciation tax shield will ______.

increase

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

risk free rate

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

stand alone principle

crossover rate

the discount rate that makes the NPVs of two projects equal

sunk cost

a cost that has already been committed and cannot be recovered

The NYSE differs from the Nasdaq primarily because the NYSE has _____.

a physical location an auction market specialists

The internal rate of return is a function of ____.

a project's cash flows

The ______ can be interpreted as the capital gains yield.

constant growth rate

The SML is very important because it tells us the "going rate" for bearing ____ in the economy.

risk

dealer

Someone who maintains an inventory of stocks and buys and sells those stocks

incremental cash flows

the difference between a firm's future cash flows with a project and those without the project

Sharpe Ratio

ratio of portfolio risk premium to standard deviation

arithmetic average return

the return earned in an average year over a multiyear period

Weak Efficiency

when the price of a security reflects the past price and trading volume of the security

Using the payback period rule will bias toward accepting which type of investment?

short term investment

Using the dividend growth model requires that the growth rate be _____ the discount rate.

smaller than

The main reason for considering nonconstant growth in dividends is to allow for _____ growth rates over _____.

supernormal; some finite length of time

What are the two components of unexpected return (U) in the total return equation?

systematic portion, unsystematic portion

Which one of the following types of risk is not reduced by diversification?

systematic, or market risk

The point at which the NPV profile crosses the horizontal axis is the:

internal rate of return

The IRR rule can lead to bad decisions when cash flows are _____ or projects are mutually exclusive.

not conventional

The excess return is computed as the:

Return on a risky security minus the risk-free rate.

What is the expected return on a security with beta of 1?

The expected return on the market.

What is the term for the excess return an asset earns based on the level of risk taken?

alpha

Percentage returns are more convenient than dollar returns because they ____.

apply to any amount invested

A person who brings buyers and sellers together is called a(n)

broker

Erosion

the cash flows of a new project that come at the expense of a firm's existing projects

True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.

true

True or false: The return an investor in a security receives is equal to the cost of the security to the company that issued it.

true

a payment by a corporation to shareholders, made in either cash or stock.

dividend

True or false: Based on the discounted payback rule, an investment is acceptable if its discounted payback is less than some prespecified number of years.

true

If the growth rate (g) is zero, the capital gains yield is ____.

zero

T/F: For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False

Capital budgeting

decision-making process for accepting and rejecting projects.

IRR

discount rate that makes NPV = 0

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

1

primary market

the market in which new securities are originally sold to investors

secondary market

the market in which previously issued securities are traded among investors

opportunity cost

the most desirable alternative use of an asset given up if the company decides to go ahead with the project and use the asset

Using the SML approach, what is the expected return on a stock if its beta is equal to zero?

the risk free rate

Conventional Cash Flows

the sign of cash flows change only once

According to the CAPM, which of the following events would affect the return on a risky asset? Federal Reserve actions that affect the economy A fire in the company's plant A change in the yield on T-bills A change in the company's leadership A strengthening of the country's currency

Federal reserve actions that affect the economy A change in the yield on T-bills A strengthening of the country's currency

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

The operating cash flows from net sales over the life of the project

common stock

Term used to describe the total amount paid in by stockholders for the shares they purchase.

Diversification

(reduction of the unsystematic risk only) is achieved by adding securities to the portfolio that have low correlations with the portfolio.

cumulative voting

All directors elected at the same time

strong form efficiency

Market prices reflect all information, both public and private

designated market maker (DMM)

NYSE members who act as dealers in particular stocks. Formerly known as "specialists"

floor brokers

NYSE members who execute customer buy and sell orders

incremental cash flows

The difference between a company's future cash flows if it accepts a project and the company's future cash flows if it does not accept the project

The rate of return on which type of security is normally used as the risk-free rate of return?

Treasury bills

The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the _____.

cost of capital

The most important reason to diversify a portfolio is to:

eliminate asset-specific risk

What two factors determine a stock's total return?

expected return and unexpected return

The stand-alone principle advocates that project analysis should be based solely on which cost?

incremental

One common reason for having two classes of common stock with different voting rights is _____.

it is easier for insiders such as founding families to maintain control of the company

If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be _____.

positive

A project should only be accepted if its return is above what is ___.

required by investors

Which one of the following statements is correct? Stocks can only be assigned one dividend growth rate. Dividend growth rates must be either zero or positive. All stocks can be valued using the dividend discount models. Preferred stocks generally have variable growth rates. Stocks can have negative growth rates.

stocks can have negative growth rates

The point at which the NPV profile crosses the vertical axis is the:

sum of the cash flows of the project

Which type of risk is unaffected by adding securities to a portfolio?

systematic risk

cumulative preferred stock

Preferred stock on which undeclared dividends accumulate until paid; common stockholders cannot receive dividends until cumulative dividends are paid.

PI

Present value of future cash flows divided by the absolute value of the initial cash flow

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

semi-strong form efficiency

all public information is reflected in a stock's current price

When using the subjective approach to project analysis, a firm:

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

Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio _____.

declines

All else constant, the dividend yield will increase if the stock price ____.

decreases

True or false: Opportunity costs can be ignored when determining the financial feasibility of a project.

false

When applying two-stage growth, in the second stage, g2 _____.

must be less than R

Dividend Yield

next years annual dividend divided by this years stock price

portfolio weight

percentage of a portfolio's total value in a particular asset

broker

person who acts as a go-between for buyers and sellers of stocks and bonds

The cost of preferred stock is equivalent to the:

rate of return on a perpetuity

The arithmetic average rate of return measures the ____.

return in an average year over a given period

Equivalent Annual Cost (EAC)

the present value of a project's future, annual cash flows calculated on an annual basis

Which of the following items are included when calculating the expected return on a portfolio? 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

1, 2, 3, and 4

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

False

WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No minority shareholder would have enough votes to win any seat on the board.

Payback Period

The length of time that it takes for a project to fully recover its initial cost

Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $3.36 per share and has a beta of 1.38, all else constant, which of the following actions will increase the firm's cost of equity?

a decrease in the risk free rate

Net Present Value

a measure of how much value is created or added today by undertaking an investment.

Dividends paid to common stockholders ______ be deducted from the payer's taxable income for tax purposes.

cannot

Which one of following is the rate at which a stock's price is expected to appreciate?

capital gains yield

WACC is used to discount ______.

cash flows

When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____.

decrease

A firm's aftertax cost of debt will increase if there is a(n):

decrease in the company's tax rate

Which of the following methods for calculating the cost of equity ignores risk?

dividend growth model

side effects

effects on other existing projects of the firm that will occur only if the project is undertaken. they can be positive or negative and should be included in capital budgeting

true or false: Based on capital market history, market efficiency shows us that it is relatively simple to identify stocks that are incorrectly priced.

false

One requirement of the dividend growth model is _____.

g < R

The CPI is the most commonly used measure of

inflation

The constant growth formula calculates the stock price:

one year prior (year t) to the first dividend payment (Dt +1)

Assume a manager determines the cost of capital for a specific project based on the cost of capital at another firm with a line of business that is similar to the project. Accordingly, the manager is using the ________ approach.

pure play

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.

risk-free rate

In a ____ board, only a fraction of the directorships are up for election at any one time.

staggered

mutually exclusive projects

the acceptance of one project eliminates the possibility of accepting another

geometric average return

the average compound return earned per year over a multiyear period

Which of the following entities declares a dividend?

the board of directors

NPV

the difference between a project's market value and its cost. considered the best rule

Unconventional cash flows

the sign of cash flows changes more than once

standard deviation

the square root of the variance

What does WACC stand for?

weighted average cost of capital

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

market risk premium

The IRR is the discount rate that makes the NPV of a project equal to ______.

zero

preffered stock

A stock with dividend priority over common stock

Assume a firm has a debt-equity ratio of .62. The firm's weighted average cost of capital is the:

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

The first step in estimating cash flow is to determine the _________ cash flows.

relevant

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

risk free rate of return

unsystematic risk

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

Which of the following are expected cash flows to investors in stocks?

Capital gains and dividends

Which of the following statements regarding unsystematic risk is accurate?

It can be effectively eliminated by portfolio diversification.

stand-alone principle

Once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm." The assumption that the project evaluation can be based only on the project's incremental cash flows

Proxy Voting

a grant of authority by a shareholder allowing another individual to vote his or her shares

Shareholders typically have the right to share proportionally in ___ paid

dividends

Finding a firm's overall cost of equity is difficult because _____. there is no way to estimate it it extensively requires the use of differential equations there is no way of directly observing the return that the firm's equity investors require on their investment the federal government refuses to disclose equity costs unless the firm is in the real estate sector

there is no way of directly observing the return that the firm's equity investors require on their investment

The true risk of any investment is the _____ portion.

unanticipated

expected return

It is the return that an investor expects to earn on a risky asset in the future.

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.

Payback method

preferred stock

Stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights.

Discounted Payback Period

capital budgeting decision method that finds the present value of each cash flow before calculating a payback period. The length of time it takes the company to recover its initial cost using discounted values (PVs) of the future cash flows.

discount cash flow valuation

computing the value of a project based on the present value of the project's anticipated cash flows

The increase in the number of stocks in a portfolio results in a(n) _____ in the average standard deviation of annual portfolio

decrease

excess rate of return

difference between the rate of return on a risky asset and the risk-free rate of return

A decrease in ___ will increase the current value of a stock according to the dividend growth model

discount rate

The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the:

discounted payback period.

he price of a share of common stock is equal to the present value of all expected future___?

dividends

The assumption of constant growth infers that _________.

dividends change at a constant rate

The total dollar return on a stock is the sum of the

dividends; capital gains

pro forma financial statements

financial statements with the future years projected cash flows

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

increases; increases

When assuming nonconstant growth in dividends, to avoid the problem of having to forecast and discount an infinite number of dividends, we must require that the dividends _____.

start growing at a constant rate sometime in the future

beta coefficient

the amount of systematic risk present in a particular risky asset relative to that in an average risky asset

True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.

true

standard deviation is the measure of ____

volatility

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 zero

The dividend yield is determined by dividing the expected dividend (D1) by _____.

the current price (P0)

risk premium

the difference between the return on a risky investment and the return on a risk-free investment

A project has a net present value of zero. Given this information:

the project's cash inflows equal its cash outflows in current dollar terms

Preferred stock ___.

pays dividends in perpetuity pays a constant dividend

Variance

standard deviation squared