finance final exam

Systematic Risk

risk that affects a large number of assets, or affects the entire market. - Examples: BP oil spill, war, bank runs, recession, high gas prices.

Arithmetic mean

(R1 + R2. . . + Rn) / n - Used for calculating standard deviation and average return for short-term holding periods

Pro Forma Financial Statements

- Prepared by financial managers - Forward looking (projecting firm performance) - Make best estimate about future sales and expenses, given current and past information.

Erosion

A negative impact on the cash flow of an existing product from the introduction of a new product

b

A project's cash flow is equal to the project's operating cash flow: a. plus the project's depreciation expense minus both the project's taxes and capital spending. b. minus both the project's change in net working capital and capital spending. c. minus the project's change in net working capital plus all of the depreciation expenses. d. plus the project's depreciation expenses minus the project's taxes. e. minus the project's taxes.

c

A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not? (a) No; The IRR exceeds the required return. (b) No; The IRR is less than the required return. (c) Yes; The IRR exceeds the required return. (d) Yes; The IRR equals the required return. (e) No; The IRR equals the required return.

Total Dollar Return = $1 dividend + $2 capital gains

ABC stock sells for $3. Next year the stock price is $5 and the firm paid a $1 dividend

C

According to efficient market theory, a trading strategy that looks only at historical stock price movements: A. Is effective and the investor can earn abnormal returns if the market is semi-strong form efficient. B. Is effective and the investor can earn abnormal returns if market is weak form efficient. C. Is ineffective and the investor cannot earn abnormal returns even if 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

b

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0? a. Loan obtained to finance the project b. Initial investment in inventory to support the project c. Annual depreciation tax shield d. Aftertax salvage value e. Net working capital recovery

=average

Arithmetic mean = ?

a

Assume that last year T-bills returned 2.8 percent while your investment in large company stocks earned an average of 7.6 percent. Which one of the following terms refers to the difference between these two rates of return? (a) Risk premium (b) Geometric average return (c) Arithmetic average return (d) Standard deviation (e) Variance

a

Assume that last year T-bills returned 2.8 percent while your investment in large-company stocks earned an average of 7.6 percent. Which one of the following terms refers to the difference between these two rates of return? a. Risk premium b. Geometric average return c. Arithmetic average return d. Standard deviation e. Variance

Incremental Cash Flows

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

b

Estimates of the rate of return on a security based on the 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 estimate; accurately estimate

e

GL Plastics spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? a. Opportunity b. Fixed c. Incremental d. Erosion e. Sunk

e

Generally speaking, which of the following best correspond to a wide frequency distribution? a. High standard deviation, low rate of return b. Low rate of return, large risk premium c. Small risk premium, high rate of return d. Small risk premium, low standard deviation e. High standard deviation, large risk premium

=geomean

Geometric mean = ?

d

Inside 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.

D1/P0 = $2.95/$63 = 4.68%.

Kangaroo Corp. has an initial stock price of $63 per share (P0). In the next year, Kangaroo pays a dividend of $2.95 (D1). What is the Dividend Yield?

Beta

Measure of how a particular stock moves with or against the market. It is used as a measure of a stock's expected risk premium

Portfolio Weights

Most common is weighted portfolios. Assign each stock a weight according to its percentage of the portfolio.

Portfolio Variance

Must first calculate the portfolio expected return (not the individual stocks), then find the sum of squared deviations of the portfolio from the portfolio expected return

8.75

One year ago, you purchased a share of Stocks Unlimited for $48.56. Today the stock price is $57.31 and the stock has paid quarterly dividends of $0.50 per share. How much is the capital gain ($$) on this stock?

Dividend Yield + Capital Gains Yield

Percentage Returns =

Arithmetic return = 7.47% Geometric return = 6.93%

Pizza Hut's stock has had annual returns of 13.2%, 16.4%, and -7.2% over the last three years, respectively. What is the arithmetic return? The geometric return?

c

Pro forma financial statements can best be described as financial statements: (a) expressed in a foreign currency. (b) where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales. (c) showing projected values for future time periods. (d) expressed in real dollars, given a stated base year. (e) where all accounts are expressed as a percentage of last year's values.

e.

Pro forma statements for a proposed project should generally do all of the following except: a. be compiled on a stand-alone basis. b. include all project-related fixed asset acquisitions and disposals. c. include all the incremental cash flows related to the project. d. include taxes. e. include interest expense.

Project operating cash flow minus Project change in net working capital minus Project capital spending

Project Cash Flow (PCF) =

Portfolio Expected Returns

Simply weight each stock according to the holdings of that stock in proportion to the total portfolio

d

Stacy purchased a stock last year and sold it today for $4 a share more than her purchase price. She received a total of $1.15 per share 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 par value. (b) The capital gain would have been less had Stacy not received the dividends. (c) The total dollar return per share is $2.85. (d) The capital gains yield is positive. (e) The dividend yield is greater than the capital gains yield.

d

Stacy purchased a stock last year and sold it today for $4 a share more than her purchase price. She received a total of $1.15 per share 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 par value. b. The capital gain would have been less had Stacy not received the dividends. c. The total dollar return per share is $2.85. d. The capital gains yield is positive. e. The dividend yield is greater than the capital gains yield.

b

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

a

Standard deviation measures which type of risk? (a) Total (b) Non-diversifiable (c) Unsystematic (d) Systematic (e) Economic

a

Standard deviation measures which type of risk? a. Total b. Non-diversifiable c. Unsystematic d. Systematic e. Economic

study

Study chapter 8/9 math problems

Dividend yield = 2.67% Capital gains yield = 8.89%

Suppose a stock had an initial price of $90 per share, paid a dividend of $2.40 per share during the year, and had an ending share price of $98. What was the dividend yield and the capital gains yield?

c

The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $317,000 and expenses by $216,000. The project will require $125,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 40 percent. What is the depreciation tax shield? a. $14,400 b. $12,500 c. $8,333 d. $21,133 e. $14,400

d

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly. a. real return b. actual return c. nominal return d. risk premium e. expected return

a

The intercept point of the security market line is the rate of return which corresponds to: (a) the risk-free rate. (b) the market rate. (c) a return of zero. (d) a return of 1.0 percent. (e) the market risk premium.

c

The primary purpose of portfolio diversification is to: a. increase returns and risks. b. eliminate all risks. c. eliminate asset-specific risk. d. eliminate systematic risk. e. lower both returns and risks.

c

The rate of return on which type of security is normally used as the risk-free rate of return? a. Long-term Treasury bonds b. Long-term corporate bonds c. Treasury bills d. Intermediate-term Treasury bonds e. Intermediate-term corporate bonds

d

The reward-to-risk ratio for Stock A is less than the reward-to-risk ratio of Stock B. Stock A has a beta of .82 and Stock B has a beta of 1.29. This information implies that: a. Stock A is riskier than Stock B and both stocks are fairly priced. b. Stock A is less risky than Stock B and both stocks are fairly priced. c. either Stock A is underpriced or Stock B is overpriced or both. d. either Stock A is overpriced or Stock B is underpriced or both. e. both Stock A and Stock B are correctly priced since Stock A is less risky than Stock B.

d

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs? (a) Sunk (b) Total (c) Variable (d) Incremental (e) Fixed

- Dividend Yield = $0/$32.50 = 0% - Capital Gains Yield = $41.75 - $32.50/$32.5 = 28.46%

The stock price of Scarlett Scarves last year was $32.50 (P0). This year the stock price is $41.75 (P1). The firm paid no dividends. What is the Capital Gains Yield?

a

The systematic risk of the market is measured by a: a. beta of 1. b. beta of 0. c. standard deviation of 1. d. standard deviation of 0. e. variance of 1.

Dividend Income + Capital Gain (Loss)

Total Dollar Return = ?

(a) What is the Dividend Yield? 7.08% (b) What is the Capital Gains Yield? 5.54% (c) What is the Total Percentage Return? 12.62%

TravelZoo's stock price last year was $16.25 (P0). This year TravelZoo paid a dividend of $1.15 (D1) and the stock price increased to $17.15 (P1). (a) What is the Dividend Yield? (b) What is the Capital Gains Yield? (c) What is the Total Percentage Return?

a

Unsystematic risk: a. can be effectively eliminated by portfolio diversification. b. is compensated for by the risk premium. c. is measured by beta. d. is measured by standard deviation. e. is related to the overall economy.

c

Which one of the following categories of securities had the highest average annual return for the period 1926-2016? a. U.S. Treasury bills b. Large-company stocks c. Small-company stocks d. Long-term corporate bonds e. Long-term government bonds

a

Which of the following statements concerning risk are correct? I. Non-diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non-diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid. (a) I and III only (b) II and IV only (c) I and II only (d) III and IV only (e) I, II, and III only

c

Which of the following yields on a stock can be negative? a. Dividend yield b. Capital gains yield c. Capital gains yield and total return d. Dividend yield, capital gains yield, and total return e. Dividend yield and total return

c

Which one of the following best describes the concept of erosion? a. Expenses that have already been incurred and cannot be recovered b. Change in net working capital related to implementing a new project c. The cash flows of a new project that come at the expense of a firm's existing cash flows d. The alternative that is forfeited when a fixed asset is utilized by a project e. The differences in a firm's cash flows with and without a particular project

c

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? (a) Providing both ketchup and mustard for customers' use (b) Repairing the roof of the hot dog stand because of water damage (c) Selling fewer hot dogs because hamburgers were added to the menu (d) Offering french fries but not onion rings (e) Losing sales due to bad weather

c

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach? a. Providing both ketchup and mustard for customers' use b. Repairing the roof of the hot dog stand because of water damage c. Selling fewer hot dogs because hamburgers were added to the menu d. Offering french fries but not onion rings e. Losing sales due to bad weather

c

Which one of the following categories of securities had the highest average annual return for the period 1926-2016? (a) U.S. Treasury bills (b) Large-company stocks (c) Small-company stocks (d) Long-term corporate bonds (e) Long-term government bonds

e

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2016? a. Long-term government bonds b. Small-company stocks c. Large-company stocks d. Long-term corporate bonds e. U.S. Treasury bills

c

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero? (a) EBIT + Depreciation (b) EBIT(1 + Taxes) (c) Net income + Depreciation (d) (Sales − Costs)(1 − Depreciation)(1 − Taxes) (e) (Sales − Costs)(1 − Taxes)

c

Which one of the following is a project cash inflow? Ignore any tax effects. a. Decrease in accounts payable b. Increase in accounts receivable c. Decrease in inventory d. Depreciation expense e. Equipment acquisition

b

Which one of the following is an example of a sunk cost? (a) $1,500 of lost sales because an item was out of stock (b) $1,200 paid to repair a machine last year (c) $20,000 project that must be forfeited if another project is accepted (d) $4,500 reduction in current shoe sales if a store commences selling sandals (e) $1,800 increase in comic book sales if a store ceases selling puzzles

b

Which one of the following is an example of a sunk cost? a. $1,500 of lost sales because an item was out of stock b. $1,200 paid to repair a machine last year c. $20,000 project that must be forfeited if another project is accepted d. $4,500 reduction in current shoe sales if a store commences selling sandals e. $1,800 increase in comic book sales if a store ceases selling puzzles

e

Which one of the following is an example of unsystematic risk? (a) An across the board increase in income taxes (b) Adoption of a national sales tax (c) Decrease in the national level of inflation (d) An increased feeling of global prosperity (e) National decrease in consumer spending on entertainment

a

Which one of the following is least apt to reduce the unsystematic risk of a portfolio? (a) Reducing the number of stocks held in a portfolio (b) Adding bonds to a stock portfolio (c) Adding international securities into a portfolio of U.S. stocks (d) Adding U.S. Treasury bills to a risky portfolio (e) Adding technology stocks to a portfolio of industrial stocks

c

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

b

Which one of the following should earn the highest risk premium based on CAPM? a. Diversified portfolio with returns similar to the overall market b. Stock with a beta of 1.38 c. Stock with a beta of .74 d. U.S. Treasury bill e. Portfolio with a beta of 1.01

d

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. All securities provide the same positive rate of return when the market is efficient.

b

Which one of the following statements is correct concerning a portfolio beta? (a) Portfolio betas range between −1.0 and +1.0. (b) A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio. (c) A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification. (d) A portfolio of U.S. Treasury bills will have a beta of +1.0. (e) The beta of a market portfolio is equal to zero.

Total Dollar Return = $1 dividend + $5 capital gains

XYZ stock sells for $300. The next year the stock price is $305 and the firm paid a $1 dividend

B

You have $30,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 11 percent and Stock Y with an expected return of 9 percent. If you goal is to create a portfolio with an expected return of 10.42 percent, how much money will you invest in Stock X and Stock Y? A. Stock X, $8,700; Stock Y, $21,300 B. Stock X, $21,300; Stock Y, $8,700 C. Stock X, $27,300; Stock Y, $2,700 D. Stock X, $2,700; Stock Y, $27,300

Geometric mean

[(1 + R1) x (1 + R2). . . x (1 + Rn)]^1/n - 1 - Used for calculating long-term (buy-and-hold) returns.

Side Effects/Spillover

actions or events resulting from investing in a project that impact another part of the firm. Can be positive or negative.

Weak Form

assumes all past information is fully reflected in stock prices. Thus cannot earn abnormal returns simply by following past stock price trends or looking at past annual reports.

Semi-Strong Form

assumes stock prices fully and immediately incorporate all past and public information. Cannot earn abnormal returns from examining press releases and annual reports. The instant information is made publicly available it is incorporated into stock prices.

Strong Form

assumes stock prices fully incorporate past information, public information and private information. Thus cannot earn abnormal returns even with inside information

Stand Alone Principle

concept that views each project as a "mini-firm" with its own cash flow and profits / losses.

Sunk Costs

costs that have already been paid or incurred; since paid whether or not the project is undertaken, not considered (not relevant cash flow).

Net Working Capital

difference between current assets and current liabilities.

Financing Costs

ignore interest paid to banks and bondholders and dividends paid to shareholders - These are financing costs!

Unsystematic Risk

influences only specific firms, specific industries, or specific regions. - As name implies, is specific to firm (or industry) - Risk is limited - does not impact the entire market - Since only affects a portion of the economy, can be diversified away. - Examples: mad cow disease, auto workers strike

Opportunity Costs

not a cash expense, but an indirect expense. The cost of giving up an alternative; foregone opportunity.

Risk Premium

the additional return above the "risk free" rate that compensates for bearing risk.