Finance
Which of the following are reasons why IRR continues to be used in practice? Multiple select question. Businesspeople prefer to talk about rates of return. It is easier to communicate information about a proposal with an IRR. The IRR of a proposal can be calculated without knowing the appropriate discount rate. The IRR allows the correct ranking of projects.
- The IRR of a proposal can be calculated without knowing the appropriate discount rate. - Business people prefer to talk about rates of return - It is easier to communicate information about a proposal with an IRR
Which of the following are methods of calculating the MIRR of a project? Multiple select question. The Present Value Approach The Combination Approach The Reinvestment Approach The Discounting Approach
- The Reinvestment Approach - The Discounting Approach - The Combination Approach
Which of the following present problems when using the IRR method? Multiple select question. larger cash flows later in the project non-conventional cash flows mutually exclusive projects a high discount rate
- non-conventional cash flows - mutually exclusive projects
In general, NPV is ___. Multiple select question. negative for discount rates above the IRR positive for discount rates below the IRR equal to zero when the discount rate equals the IRR positive for discount rates above the IRR
-negative for discount rates above the IRR -equal to zero when the discount rate equals the IRR -positive for discount rates below the IRR
One of the flaws of the payback period method is that cash flows after the cutoff date are ___. Multiple choice question. not considered in the analysis reserved for future projects given greater value given special consideration
-not considered in the analysis
Which of the following are weaknesses of the payback method? Multiple select question. The cutoff date is arbitrary. All cash flows are included in the payback period. Cash flows received after the payback period are ignored. Time value of money principles are ignored.
-the cutoff date is arbitrary -cash flows received after the payback period are ignored -time value of money principles are ignored
The Combination MIRR method is used by the Excel MIRR function and uses which of the following? Multiple select question. Discounting ALL cash inflows to time 0 A financing rate for discounting Compounding ALL cash flows to the end of the project A reinvestment rate for compounding Compounding cash inflows to the end of the project A single discount rate for both discounting and compounding Discounting all cash outflows to time 0
A financing rate for discounting A reinvestment rate for compounding Compounding cash inflows to the end of the project Discounting all cash outflows to time 0
The ____ price index is a commonly used measure of inflation
Consumer
True or false: The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.
False. The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its initial cost.
_____ is a measure of how much value is created or added by undertaking an investment.
NPV
If a project has multiple internal rates of return, which of the following methods should be used? Multiple select question. MIRR IRR NPV
NPV MIRR
The risk ____ can be interpreted as the reward for bearing risk
Premium
Rank the following investments from highest to lowest risk based on the capital market history from 1926-2014 (table 10.3): long-term government bonds, long-term corporate bonds, small-company common stock, US T-bills, large-company common stock.
Small-company common stock Large-company common stock Long-term corporate bonds Long-term government bonds US T-bills
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 + _____ rate raised to the nth power.
The Discount
True or false: A project with non-conventional cash flows will produce two or more IRRs.
True(An IRR will result for every change in sign in the cash flow stream)
Rank the following investments from lowest historical risk premium ro highest: long-term corporate bonds, US T-bills, large-company stocks, small-company stocks
US T-Bills Long-Term Corporate Bonds Large-Company Stocks Small-Company Stocks
The multiple rates of return problem is the possibility that more than one discount rate may make the NPV of an investment equal to ______.
Zero
Which of the following are ways to make money by investing in stocks? (select all that apply) a. Dividends b. Capital Gains c. Amortization d. Interest
a & b
If a project has multiple internal rates of return, which of the following methods should be used? (select all that apply) a. MIRR b. IRR c. NPV
a & c
The true risk of any investment comes from (select all that apply): a. Unanticipated events b. Forecasts c. Surprises d. Expectations
a & c
Which of the following present problems when using the IRR method? (select all that apply) a. Non-conventional cash flows b. High discount rate c. Mutually exclusive projects d. Larger cash flows later in the project
a & c
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds: Multiple choice question. the required rate of return a target average accounting return the internal rate of return the net present value
a target average accounting return
Which of the following are examples of a portfolio? (select all that apply) Investing $100,000 in the stocks of 50 publicly traded corporation s Investing $100,000 in a combination of US and Asian stocks Investing $100,000 in a combination of stocks and bonds Investing $100,000 to buy 100 shares of the best performing stock on the NYSE
a, b, & c
Which of the following are methods of calculating the MIRR of a project? a. Combination Approach b. Reinvestment Approach c. Discounting Approach d. PV Approach
a, b, & d
Which of the following are weaknesses of the payback method? (select all that apply) a. The cutoff date is arbitrary b. Time value of money principles are ignored c. All cash floes are included in the payback period d. Cash flows received after the payback period are ignored
a, b, & d
What are the advantages of the payback period method for management? (select all that apply) a. Easy to use b. Adjusts for the discount rate c. Allows lower level managers to make small decisions effectively d. Ideal for minor projects
a, c, & d
A project should be _____ if NPV is greater than zero. a. Accepted b. Delayed c. Rejected
a.
Bonds used in Ibbotson SBBI long-term US government bond portfolio had maturities of ___ years a. 20 b. 15 c. 30 d. 10
a.
How does the timing and the size of cash flows affect the payback method? Assume the project does payback within the project's lifetime. a. An increase in the size of the first cash inflow will decrease the payback period, all else held constant b. A delay in receiving the cash inflows will decrease the payback period c. The timing but not the size of the cash flows affects the payback period d. Receiving every cash inflow sooner will increase the payback period, all else held constant
a.
If an asset has a reward-to-risk ratio of 6%, that means it has a ____ of 6% per unit of _____ a. Risk premium; systematic risk b. Systematic risk; risk premium c. Return; risk d. Return; systematic risk
a.
T/F: A capital gain on a stock is counted as part of the total return whether or not the fain is realized from selling the stock a. True b. False
a.
T/F: A disadvantage of the AAR is that it does not take into account the time value of money a. True b. False
a.
T/F: The expected return is the return that an investor expects to earn on a risky asset in the future. a. True b. False
a.
T/F: The measure of average accounting profit is the numerator on the AAR formula a. True b. False
a.
T/F: Under a strong form, there is no such thing as insider information a. True b. False
a.
The Average Accounting Return is defined as: a. Average net income / average book value b. Average net income / initial project cost c. Average book value / average net income d. Average book value / initial project cost
a.
The IRR is a function of ______ a. A project's cash flows b. The market interest rate c. A project's opportunity costs d. The cost of debt incurred by a project
a.
The discounted cash flow valuation shows that higher cash flows earlier in a project's life are _____ valuable than higher cash flows later on a. More b. Less
a.
The payback period rule ____ a project if it has a payback period that is less than or equal to a particular cutoff date. a. Accepts b. Rejects
a.
Under a weak form, stock prices are nothing more than a reflection of past prices a. True b. False
a.
What is an unsystematic risk? a. Affects a single asset or a small group of assets b. Always caused by external factors c. Affects all assets in a diversified portfolio d. Unavoidable risk
a.
What is the average return or large stocks? a. 12.1% b. 16.5% c. 20.2% d. 19.4%
a.
What is the risk premium of long-term government bonds? a. 2.6% b. 6.4% c. 2.2% d. 9.4%
a.
What is the risk premium of small stocks? a. 13.1% b. 16.4% c. 12.2% d. 19.4%
a.
The PI rule for an independent project is to ______ the project if the PI is greater than 1. Multiple choice question. reject accept delay
accept
Based on the average accounting return rule, a project is _____ if its average accounting return exceeds a target average accounting return. Multiple choice question. rejected acceptable break-even blue-chip
acceptable
Percentage returns are more convenient than dollar returns because they (select all that apply): a. Are more accurate than dollar amounts b. Allow comparison against other investments c. Apply to any amount invested d. Avoid using the dollar sign
b & c
Unsystematic risk will affect (select all that apply) a. The market as a whole b. Firms in a single industry c. A specific firm d. All manufacturing firms
b & c
Which of the following states is (are) true about variance? (select all that apply) a. Measures a security's expected return over many periods b. Standard deviation is the square root of variance c. Computation of variance requires the use of a computer d. A measure of the squared deviations of a security's return from its expected return
b & d
Which two factors determine a stock's total return? (select all the apply) a. Bond rates b. Unexpected return c. Abnormal return d. Expected return
b & d
Which of the following are reasons why IRR continues to be used in practice? (select all that apply) a. Allows the correct ranking of projects b. Proposal can be calculated without knowing the appropriate discount rate c. Businesspeople prefer to talk about rates of return d. Easier to communicate info about a proposal with IRR
b, c, & d
A portfolio can be described by its portfolio weights which are defined as _________ a. The percentage of dollars invested in each asset class b. The percentage of dollars invested in each asset c. The dollars invested in each asset class d. The dollars invested in each asset
b.
A positive capital gain on a stock results from ____. a. Increase in the coupon rate b. Increase in price c. Increase in the dividend d. Decrease in price
b.
A(n) ____ project does not rely on the acceptance or rejection of another project a. Dependent b. Independent c. Mutually exclusive d. Co-dependent
b.
An efficient market is one in which any change in available information will be reflected in the company's stock price ____ a. At least within a week b. Immediately c. In a day d. In two days
b.
An investment will have a negative NPV when its expected return is _____ _____ what the financial markets offer for the same risk a. Greater than b. Less than c. Equal to
b.
Beta tells us the amount of _____ risk of an asset or portfolio relative to _____ a. Unsystematic; the risk-free asset b. Systematic; an average risky asset c. Systematic; the risk-free asset d. Unsystematic; an average risky asset
b.
Between 1926 to 2017, which type of risk was the highest? a. Average Return of Large Stock b. Average Return of Small Stock c. Risk Premium of Long-Term Government Bonds d. Risk Premium of Long-Term Corporate Bonds
b.
If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____ a. Has a low level of risk b. Is highly risky c. Is risk-free
b.
More volatility in returns produces ____ difference between the arithmetic and geometric averages a. A smaller b. A larger c. No change in the
b.
T/F: An advantage of the AAR is that it is based on book values, not market values a. True b. False
b.
T/F: Because T-bills have low risk relative to common stocks, T-bills cannot outperform common stocks a. True b. False
b.
T/F: Calculating the expected return is the last step in the computation of variance a. True b. False
b.
T/F: Portfolio weights can be defined as the dollars invested in each asset a. True b. False
b.
T/F: The average return of a given period is typically not a good estimate of the returns over that same period a. True b. False
b.
T/F: The discounted cash flow (DCF) valuation estimates future values as the difference between the market price and the cost of the investment. a. True b. False
b.
T/F: The payback period takes into consideration the time value of money. a. True b. False
b.
T/F: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows much be smaller than the initial investment. a. True b. False
b.
T/F: The smaller the variance or standard deviation is, the more spread out returns will be a. True b. False
b.
The PI rule for an independent project is to ____ the project if the PI is greater than one. a. Reject b. Accept c. Delay
b.
The ____ is best suited for decisions on relatively small, minor projects while ___ is more appropriate for large complex projects. a. Payback period; URL b. Payback Period; NPV c. IRR; NPV
b.
The average return on the stock market can be used to _____. a. Accurately forecast the market's returns in the future b. Compare stock returns wit the returns on other securities c. Find ways to beat the market
b.
The risk-return relationship states that a riskier investment should demand a ____ return. a. Equal b. Higher c. Lower
b.
Under the semi-weak form, all public information affects the stock price a. True b. False
b.
What is an uncertain or risky return? a. The portion of return that depends on information that is currently known b. The portion of return that depends on information that is currently unknown c. The portion of return that is unaffected by present or future information d. The return hat is classified as risky by bond rating agencies
b.
What is the average return of long-term corporate bonds? a. 2.1% b. 6.4% c. 2.2% d. 9.4%
b.
What is the average return of small stocks? a. 12.1% b. 16.5% c. 20.2% d. 19.4%
b.
What is the definition of expected return? a. Expected variation in return on a risky asset b. Return that an investor expects to earn on a risky asset in the future c. Return that has earned in the past on a risky asset d. Variation in return during that last period
b.
Arithmetic average produces _____ results; geometric average produces ____ results a. Optimistic; optimistic b. Pessimistic; pessimistic c. Optimistic; pessimistic d. Pessimistic; optimistic
c.
Between 1926 to 2017, which type of risk was the lowest? a. Average Return of Large Stock b. Average Return of Small Stock c. Risk Premium of Long-Term Government Bonds d. Risk Premium of Long-Term Corporate Bonds
c.
Historically, the real return on Treasury bills has been: a. Quite high b. Misunderstood c. Quite low d. Negative
c.
IRR must be compared to the ____ in order to determine the acceptability of a project a. Federal funds rate b. Inflation rate c. Required return
c.
If you wish to create a portfolio of stocks, what is the required minimum number of stocks? a. You must invest in stocks of at least 10 corporations b. You must invest in at least 2 stocks of 1 corporation c. You must invest in stocks of more than one corporation d. You must invest in the stocks of at least 30 corporations
c.
The NPV is ____ if the required return is less than the IRR, and it is ____ if the required return is greater than the IRR. a. Negative, positive b. Positive, positive c. Positive, negative d. Negative, negative
c.
The ___ method evaluates a project by determining the time needed to recoup the initial investment a. Accounting Rate of Return b. Internal Rate of Return c. Payback
c.
The payback period can lead to foolish decisions if it is used too literally because: a. It ignored the initial cost b. It always includes all the cash flows c. It ignores other cash flows d. It uses an arbitrary discount rate
c.
What is a risk premium? a. A numerical estimate of beta b. A fee charged to investors by the SEC that allows them to invest in risky securities c. Additional compensation for taking risk, over and about the risk-free rate d. The return on risk-free securities
c.
What is the average return of long-term government bonds? a. 2.1% b. 5.4% c. 6.0% d. 9.4%
c.
What is the risk premium of large stocks? a. 9.1% b. 6.4% c. 8.7% d. 9.4%
c.
What is the risk premium of long-term corporate bonds? a. 2.0% b. 6.0% c. 3.0% d. 9.0%
c.
When a company declares a dividend, shareholders generally receive ___. a. Promissory notes b. Store credit c. Cash d. Interest income
c.
When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market: a. Reversed its position based on the news b. Doesn't pay attention to news items c. Already knew about most of the news items
c.
The Profitability Index is also called the __________ ratio. Multiple choice question. cost-benefit investment-benefit cost-cashflow cost-investment
cost-benefit
According to the AAR rule, a project is acceptable if its average accounting return exceeds: a. The required rate of return b. The NPV c. The IRR d. A target average accounting return
d.
How are the unsystematic risks of two different companies in two different industries related? a. Negative relationship b. Positive or negative relationship c. Positive relationship d. No relationship
d.
If investors are risk-averse, it is reasonable to assume that the risk premium for the stock market will be: a. Negative b. Unimaginably large c. Zero d. Positive
d.
In capital budgeting, ____ determines the dollar value of a project to the company a. Net Income b. NFV c. The CEO d. NPV
d.
In the Ibbotson-Sinquefield studies, US Treasury bill data is based on T-bills with a maturity of ____ month(s) a. 3 b. 6 c. 9 d. 1
d.
The standard deviation is ____. a. = to the sum of the deviations of actual returns from the average return b. = to the sum of deviations divided by the number of observations c. The square of the variance d. The square root of the variance
d.
What is a systematic risk? a. Affects only one or a few assets b. Caused by failure of the internal control system of a corporation c. Increases in a systematic, gradual fashion d. Pertains to a large number of assets
d.
What is the average return of US Treasury bills? a. 2.1% b. 6.4% c. 2.2% d. 3.4%
d.
What is the primary concern of the payback period rule? a. Whether the bank requires a higher interest rate than the market b. How long until the loan on you investment comes due c. Whether you deserve to get your money back d. How long it takes to recover the initial investment
d.
True or false: An advantage of the AAR is that it is based on book values, not market values.
false
True or false: The PI always results in the correct decision in comparisons of mutually exclusive investments. True false question. True False
false
True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.
false
True or false: There is only one way to calculate the modified IRR.
false
True or false: The IRR is easy to use because you only need to know the appropriate discount rate.
false, You need the discount rate to calculate the NPV but it is not required for the IRR calculation.
The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment. Multiple choice question. positive previous future
future
A(n) ______ project does not rely on the acceptance or rejection of another project. Multiple choice question. mutually exclusive co-dependent independent dependent
independent
The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its _____ _____. Multiple choice question. interest rate discount rate coupon rate initial cost
initial cost
Which of the following is a disadvantage of the Profitability Index? Multiple choice question. It is useful when capital is rationed. It cannot rank mutually exclusive projects. It is closely related to NPV. It is easy to understand.
it cannot rank mutually exclusive projects
if a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered _______________. Multiple choice question. independent inter-dependent co-dependent mutually exclusive
mutually exclusive
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada? Multiple select question. payback method internal rate of return accounting rate of return net present value profitability index
net present value internal rate of return
The NPV is ______ if the required return is less than the IRR, and it is ______ if the required return is greater than the IRR. Multiple choice question. negative, negative positive, positive positive, negative negative, positive
positive, negative
According to the basic IRR rule, we should: Multiple choice question. reject a project if the IRR is greater than the required return reject a project if the IRR is less than the required return accept the project if the IRR is less than the required return reject a project if the IRR is less than 10%
reject a project if the IRR is less than the required return
If the IRR is greater than the _______ ________, we should accept the project. Multiple choice question. required return inflation rate tax rate payback period
required return
Internal rate of return (IRR) must be compared to the ________ in order to determine the acceptability of a project. Multiple choice question. required return federal funds rate inflation rate
required return
True or false: A disadvantage of the AAR is that it does not take into account the time value of money.
true
True or false: According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), the internal rate of return and the NPV are the two most popular capital budgeting methods used by firms in the US and Canada.
true
True or false: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.
true
The multiple rates of return problem is the possibility that more than one discount rate may make the net present value of an investment equal to____
zero
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime. Multiple choice question. A delay in receiving the cash inflows will decrease the payback period. An increase in the size of the first cash inflow will decrease the payback period, all else held constant. Receiving every cash inflow sooner will increase the payback period, all else held constant. The timing but not the size of the cash flows affects the payback period.
• An increase in the size of the first cash inflow will decrease the payback period, all else held constant
In general, NPV is ___. Multiple select question. negative for discount rates above the IRR positive for discount rates below the IRR positive for discount rates above the IRR equal to zero when the discount rate equals the IRR
• Equal to zero when the discount rate equals the IRR • Positive for discount rates below the IRR • Negative for discount rates above the IRR
