Finance Exam #3

The change in a firm's future cash flows that results from adding a new project are referred to as _____ cash flows

incremental

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

inflation exceeding market expectations

The cost of preferred stock

is equal to the preferred stock's dividend yield

Systematic risk

is measured by beta

The cost of capital for a project is primarily determined by the project's

level of risk

A security's risk premium is equal to the

market rate minus the inflation rate

In an efficient market, a security with a beta of 1.03 will have a rate of return that plots:

on the SML just to the right of the market return

The percentage of a portfolio's value that is represented by a single security is referred to as the

portfolio weight

A pro forma financial statement is a financial statement that

projects future years' operations

Using the weighted average cost of capital (WACC) of another firm as the required return for a project is referred to as the

pure play approach

Diversifying a portfolio across various sectors and industries will tend to

reduce the firm-specific risk.

An unexpected return is a return that

results from a surprise announcement or event

The cost of equity for ABC Industries is defined as the:

return that ABC's shareholders require on their investment in the firm

The positive linear function depicting the relationship between beta and the expected return is called the

security market line

The analysis of the effect that a single variable has on the net present value of a project is called _____ analysis

sensitivity

Which one of the following represents the key weakness of the dividend growth model?

sensitivity of the model to the rate of dividend growth

If the risk-free rate of return decreases while the market rate of return remains constant, then the

slope of the security market line will increase

The situation that exists when the units within a business are allotted a fixed amount of money for capital budgeting is referred to as

soft rationing

Beta = 1

stock has average risk

Beta > 1

stock is greater than average

Beta < 1

stock with less than average risk

What is the name given to the process of assigning discount rates to projects by utilizing a stair step method that assigns projects to various risk classes?

subjective approach

A U.S. depreciation system that allows for more rapid depreciation under various classifications is called

the accelerated cost recovery system

The concept of investing in a variety of diverse assets to reduce risk is referred to as

the principle of diversification

Beta Measures

- Amount of systematic risk present in a particular risky asset relative to that in an average risky asset

The opportunity to modify a project in the future is referred to as

A managerial option

Systematic Risk

A risk that influences a large number of assets. Also, market risk.

The most valuable alternative that is forfeited if a particular investment is undertaken is called

An opportunity cost

The situation a firm faces when it has positive net present value projects but cannot obtain financing for those projects is referred to as

Capital rationing

The cash flows of a new project that result from a reduction in the cash flows from a firm's existing projects are called

Erosion

When a firm cannot raise financing for a project under any circumstances, the firm is facing a situation known as

Hard Rationing

The analysis of the effects that what-if questions have on the net present value of a project is called _____ analysis

Scenario

The assumption that a project will be evaluated based on its incremental cash flows is referred to as the

Stand-alone principle

The options a firm has to expand into related business products are referred to as

Strategic options

The risk premium for a security is based on which one of the following types of risk?

Systematic

standard deviation

a computed measure of how much scores vary around the mean score

A sunk cost is

a cost that has already been incurred and cannot be recouped

Systematic risk is

a risk that affects a large number of assets

unsystematic risk

a risk that affects at most a small number of assets. Also, unique or asset-specific risk

Which one of the following best exemplifies unsystematic risk?

an unexpected increase in the sales of a firm

he equation that is represented graphically by the security market line is called the:

capital asset pricing model

Which one of the following is the primary determinant of the cost of capital for a proposed project?

combined sources of funds used to finance the project

The return that lenders require on a firm's borrowed funds is called the firm's

cost of debt

The weighted average cost of capital is defined as the weighted average of a firm's

cost of equity and its aftertax cost of debt

A change in a firm's tax rate will not affect the firm's after-tax cost of

equity

The return on a risky asset that is anticipated in the future is called the

expected return

A portfolio is a(n)

group of assets held by an investor

The cost of capital for a project depends primarily on the

use of the funds

DL Industries just called a press conference and is now announcing that the firm is restructuring and will be closing two manufacturing facilities. This announcement:

will have no effect on the firm's stock price if the announcement was expected

All else constant, an increase in a firm's cost of debt

will result in an increase in the firm's cost of capital