FINC312: Chapter quiz questions
Imagine a conglomerate with three divisions. Divisions A's assets have a beta of 0.5 ; division B's assets, a beta of 1.0 ; and division C's assets, a beta of 1.5. If the company uses the average, 1.0, when valuing projects for all its divisions, which division will the company overinvest in?
Division C
true or false: a high ROE is always a good thing
False
BHP Billiton is one of the world's largest mining companies, and accounts receivable make up 21% of its total assets (in 2016). Which of the following companies is most likely to owe BHP Billiton money as part of BHP Billiton's accounts receivables?
United States Steel Corporation, a steel manufacturer
In 2012, Facebook conducted its initial public offering and sold 421 million shares to the public for the first time. Which player in the capital markets helped in sell these shares?
The sell side
what types of companies are more likely to have high leverage?
companies with high growth opportunities in new industries
which of the following is NOT an example of a valuation multiple?
current assets to current liabilities
Home Depot, a home improvement supply store, issued $2 billion in debt in late 2016. What is the main difference between debt and other liabilities, like accounts payable?
debt carries an explicit interest rate
Why does finance add back depreciation and in its measure of economic returns?
depreciation isn't a cash expense
true or false: you can always increase company value by adding leverage
false
companies with higher betas have:
higher costs of equity
You oversee the purchasing department of Best Buy, the electronics and appliance retailer, and are concerned about the funding gap in your cash conversion cycle. Which of the following will not reduce the funding gap? (Reducing funding gap is good)
increasing sales
when companies report earnings that are only a few cents below their previous estimates, why do their stock prices go down by so much?
investors can't be certain if the company failed to meet its estimates because of coincidence or bad luck, or if the missed estimate is a signal that management is obscuring
what is the main benefit of diversification?
it decreases the amount of risk in your portfolio, relative to the amount of return
Which of the following is true about free cash flow?
it is for all capital providers and is tax adjusted
Which of the following constituencies care most about a company's current ratio?
its suppliers
for a company with returns to capital of 5% and costs of capital of 10%, its market-to-book ratio will be:
less than 1
increased leverage allows companies to control more assets and increase their ROE. what's bad about leverage?
leverage multiple losses, too, as it increase a company's risk
You are considering starting up a five guys burgers & fries franchise, which you estimate will cost $250,000. You expect to make considerable free cash flow for the next five years, after which you will sell off the franchise for $200,000. The discounted values of those cash flows are $90,000, $80,000, $70,000, $60,000, and $180,000 (which includes the fifth-year cash flow, as well as the proceeds of the sale), respectively. Which of the following is likely to be the net present value of your investment?
$230,000
In 2016, Pfizer invested $350 million in a new plant in China. For which of the following present values of the plant's cash flows does that decision make sense? (choose all that apply)
$400 million $500 million
which of the following are possible consequences of the usual compensation model and industrial structure for equity analysts?
- analysts will work hard to provide accurate valuation for companies - high ranking analysts may "herd" by choosing valuations similar to other analysts to protect their position in the rankings - low ranked analysts may outlandish and contrary predictions, hoping that a lucky break will propel them to the top of the rankings
which of the following can be a source of value creation?
- returns to capital that exceed costs of capital - reinvesting profits to grow
Which of the following is a disagreement between finance and accounting? Choose all that apply
- what constitutes economic returns (net profit or free cash flow) - how to value assets (historical cost or future cash flows) - how to value equity (book value or market value)
In October 2016, Microsoft announced a $40 billion share buyback program. Which of the following is a reason shareholders might prefer share buybacks to dividends?
-Share repurchase can be taxed at a favorable rate compared to dividends (using the capital gains tax rate instead of the income tax rate) -Share repurchase signal that the company thinks its stock is undervalued
If your supplier offers you a 2% discount if you pay twenty days earlier than you would have otherwise, how much is the supplier implicitly charging you for a twenty-day loan?
2%
United States steel corporation has a receivables collection period of thirty-three days, a days inventory of sixty-eight days, and a payables period of forty-nine days. How long is its funding gap?
52 days
Which of the following projects will surely create value for your business?
A project with an NPV of $100 million
you are excited about an investment opportunity in Dow Chemical, a multinational chemical corporation, because it is undervalued relative to peers. which of the following companies should you short to better capture the potential outperformance of Dow?
Bayer, a multinational chemical and pharmaceutical company
Why might an unscrupulous CEO perform a share buyback?
Increase EPS to meet a target, to send a false signal that the CEO believes their stock is undervalued ( share buyback decreases the number of shares outstanding)
Calculate the enterprise value of the firm
Market value of equity + debt - cash
Your company builds a new plant with an investment of $100 million and an expected present value from its future cash flows of $150 million. Two years later, it becomes apparent that the new product isn't selling as well as expected, and the present value of future cash flows at that point is only worth $50 million. Should the company shut down the plant?
No, the present value is still $50 million
Based on the following P/E ratios, which of the following is likely to have more growth opportunities?
P/E with the highest ratio will have more growth opportunities
Which of the following is least likely to be listed as an asset on a balance sheet?
Payments owed to Ford Motor Company by dealerships for the purchase of cars (since payments are owed this wouldn't be an asset)
Which of the following creates the most value?
Positive NPV projects
Which of the following valuation techniques reduces the risk of overpaying for an acquisition?
Scenario analysis ( allows the company to determine a more accurate value before they begin bidding)
From a finance perspective, what concern might be raised about conglomerates?
Shareholders can diversify on their own and do not need the company for better valuations
One share of facebook stock is being traded at $150. If so, which of the following does the stock market believe to be true?
The present value of all future free cash flows from Facebook's business, after netting out cash and debt, implies a facebook stock value of $150
you are considering two projects and can choose only one: the first has an IRR of 15%, and the other, an IRR of 25%. The WACC is 12%. Which project should you choose?
The project with an IRR of 25% is probably preferable, but you should conduct a DCF analysis
Your company has $1 million in free cash flows and is trying to determine how to allocate that capital among organic growth, dividends, and share buybacks. The company has the opportunity to engage in organic growth, which requires an investment of $1 million and has an NPV of $2.3 million. Alternatively, it can offer a $1 dividend to each of its one million shareholders. Or it could buy back 100,000 shares of $10 each. What should your company do?
Use $1 million for the organic growth project ( should always invest in positive NPV projects)
what is a beta?
a measure of how much a stock moves with a broader market
most equity research analysts are employed by and receive their paychecks from...
a sell side firm
Which of the following is an example of a bad incentive?
analysts are afraid to recommend "sell" for a company's stock, because that company may do not business with their employer in the future
why should companies invest in positive NPV projects?
because they create value by having returns greater than the cost of capital
What does private equity do?
buys companies, improves them, and then sells them to another private investor or the public markets
You are a manager of a hedge fund and believe that GM is going to do really well next year. Specifically, you are certain that GM is going to outperform Ford Motors Company, a rival car company, and you wish to set up a trade. which of the following is an investment strategy that will make money if you are right?
long GM, short Ford
Which ratio is the distinguishing feature of retail companies?
low receivables collection period
In 2009, Warren Buffet invested $3 billion in Dow Chemical, via an issuance of preferred stock. Which of the following is NOT an advantage of preferred stock to the owner of the preferred stock?
preferred stock dividends must be in an even numbered percentages (this is not true b/c dividends do not need to be paid in even percentages)
how can a company with sustainable returns to capital of 15% and a cost of capital of 12% maximize its value?
reinvest as many of its profits as possible
In 2016, Canadian companies issued more equity than ever before. Why does issuing equity often cause a company's stock price to decrease?
signaling (company isn't confident enough to invest in the project using debt or internal financing)
Which of the following is a reason stock prices go up after announcement of a stock buyback?
signaling - send a message that stock prices are undervalued
Which of the following companies is most likely to have the highest inventory turnover?
subway, a fast food restaurant company ( need to have fresh supply and get rid of perishable goods faster)
Which of the following is a reason for an acquisition to fail?
synergies not realized Overpayment for the acquired company cultural clashes
how do you determine the cost equity?
take the risk free rate and add the product of your equity beta and the market risk premium
which problem of capital markets might this be a manifestation of?
the principal agent problem
how do you determine your cost of debt?
your lender can tell you what your current borrowing costs are