Finance Exam 3

Corporate bonds

(a) are sold in denomination of $1,000 (b) have fixed coupon rate

While determining the cost of capital, the market value weights are

(a) based on the current market prices of securities (c) more desirable as they reflect the true market value of the capital structure

To compute the weighted average cost of capital, one must

(a) calculate the cost of each component (b) determine the weight of each component (c) multiply each weight by its corresponding component cost (d) sum these products

The most commonly used capital budgeting methods under certainty are

(a) payback (b) average rate of return (c) net present value (d) internal rate of return

The capital budgeting projects can be classified into the following category(ies)

(a) replacements (b) expansion into new products (c) expansion into existing products

Which of the following is the measure of absolute risk?

(a) semi-variance (b) standard deviation

The capital budgeting process requires

(a) the establishment of long-range objectives (b) the selection of capital expenditure proposals

In the process of determining the cost of capital, the book value weights are

(b) derived from the firm's balance sheet (c) easy to calculate

With respect to an accept-reject decision, the firm should reject the investment project if

(b) its net present value is less than zero (c) its internal rate of return exceeds zero but less than its cost of capital

12-6. Which one of the following techniques is not utilized to evaluate projects under conditions of uncertainty?

(e) pro forma income statement and balance sheet analysis Need: (a) computer simulation (b) sensitivity analysis (c) risk-adjusted discount rate (d) certainty equivalent approach

It is a given fact that the general level of stock prices and the prevailing interest on debt investments has:

An inverse relationship

Which of the following techniques ignores the time value of money criteria that should be considered in capital budgeting?

Average rate of return

When a debt investment, specifically a bond, is held to its stated redemption date, it is formally referred to as being held to its:

Maturity date

Which of the following is not a reason to illustrate the fact that net present value method is better than internal rate of return:

NPV is difficult to compute

Which one of the following capital budgeting methods does not take into account the time value of money?

Payback

Which of the following capital budgeting methods are considered unsophisticated?

Payback and average rate of return

A bond with a market price of $1,050 is said to be selling at

Premium

The marginal cost of capital is defined as

The cost of additional funds to be raised by the firm

Which of the following is not a characteristic of preferred stockholders?

They are always entitled to receive their dividends

Standard deviation is expressed in terms of

absolute values

The net cash flows from an investment project

are earnings after tax plus depreciation

For projects whose returns are stated in dollars, which of the following would provide a better measurement of risk?

coefficient of variation

The interest rate which equates the present value of the coupon interest payments and the principal repayment of a bond to its market price is called the

cost of debt, or yield to maturity

A bond's yield to maturity is the rate of return that equates the present value of principal and interest payments to the

current market price of the bond

As the general interest rates increase, one would expect the market prices of most bonds to

decline

The discounted cash flow model of valuation is: Po = D1/(Ke - g). How would Po change with a corresponding increase in risk for the firm all other things constant?

decrease

Beta may be used to classify stocks into which of the two following categories

defensive stocks and aggressive stocks

Under the certainty equivalent method of adjusting risk in capital budgeting, the certainty equivalent coefficient are calculated by

dividing certain cash flow by an uncertain cash flow

The coefficient of variation is defined as standard deviation divided by the

expected value

Debt financing has the following two types of costs

explicit cost and implicit cost

A project is acceptable when its internal rate of return is greater than

firm's cost of capital

Aggressive stocks have a beta value

greater than one

According to the risk-adjusted discount rate method for incorporating risk into capital budgeting, very risky projects are discounted by a rate

greater than the firm's cost of capital

Generally speaking, the higher the risk of a project

higher expected return

Investors' overall required rate of return on equity investments increases as a result of:

inflationary pressures and increases in the general level of interest on debt investments

The relationship between a bond's price and yield to maturity:

is inverse

The average rate of return method is inferior to the net present value method because

it does not consider the time value of money

Which of the following is not an advantage of internal rate of return method:

it requires prior computation of the cost of capital

A narrower probability distribution indicates

less risk

Defensive stocks have a beta value

less than one

Defensive stocks have their return fluctuate

less than the market index

The stocks with beta values equal to one are frequently called

neutral stocks

Two projects are mutually exclusive if

one is adopted, the other one cannot be adopted

Which of the following methods is not used to adjust a project's estimates for risk in capital budgeting?

payback

Which one of the following statements regarding the payback method is incorrect?

payback method acknowledges explicitly the cash flows beyond the payback period

The valuation principle states that the value of an asset is equal to the

present value of its expected cash flows

The economic life of a project

refers to the time period during which the project is expected to provide benefits

Coefficient of variation is expressed in terms of

relative values

For projects whose returns are stated in terms of percentages, which of the following would provide a better measurement of risk?

standard deviation

The average rate of return on a project is computed as

the average annual net profit after taxes divided by the average net investment

The after-tax cost of a bond is equal to

the before tax cost of the bond times (1 - tax rate)

In order to calculate the weighted average cost of capital, one must compute

the cost of individual components of the capital structure and the percentage composition of the capital structure

The internal rate of return is the discount rate which will equate the present value of net cash inflows to

the initial cost of investment

The profitability index is obtained by dividing the present value of net cash inflows by

the net investment

The next present value of a project is the present value of the cash inflows discounted at the cost of capital minus

the present value of the net cash investment

When the net present value of a project is zero, the discount rate is

the project's internal rate of return

Which of the following is not a characteristic of a debt security?

the rate of return required by bondholders is generally higher than that by stockholders

A bond's face value is usually

the same as its maturity value

The interest rate which equates the present value of the coupon interest payments and the principal repayment of a bond to its market price is called the

yield to maturity

The optimum capital structure is the one that

yields the lowest weighted average cost of capital

When a project's cash flows are discounted by its internal rate of return, it has a

zero net present value