CH. 9, 13, 14 Connect Q&A's
What are non-conventional cash flows?
A combination of cash outflows and inflows.
Of the options listed below, which is the best example of unsystematic risk?
A national decrease in consumer spending on entertainment
What is the first step in the Net Present Value (NPV) process?
Estimate the future cash flows.
Of the options listed below, which is the best example of systematic risk?
Investors panic causing security prices around the globe to fall precipitously.
Which of the following statements regarding unsystematic risk is accurate?
It can be effectively eliminated by portfolio diversification.
All of the following are commonly cited reasons for using the Internal Rate of Return, except:
Multiple IRR's allow the company to choose the best one when evaluating projects.
Which one of the following methods predicts the amount by which the value of a firm will change if a project is accepted?
Net present value
For the Dividend Growth Model, the equation can be written as follows: P0 = =D1/(RE - g). How can this equation be rearranged?
RE = D1/P0 + g
________ measures total risk, and ________ measures systematic risk.
Standard deviation; beta
A firm's target capital structure represents:
a fixed debt-equity ratio that the company attempts to maintain.
A project's average net income divided by its average book value is referred to as the project's average:
accounting return.
When calculating a firm's weighted average cost of capital, the capital structure weights:
are based on the market values of the outstanding securities.
Of the options listed below, which is the best measure of systematic risk?
beta
The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk.
capital asset pricing model
A firm's aftertax cost of debt will increase if there is a(n):
decrease in the company's tax rate.
When evaluating any capital project proposal, the cost of capital:
depends upon how the funds raised for that project are going to be spent.
Net present value:
is the best method of analyzing mutually exclusive projects.
Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:
is underpriced
The market risk premium equals the:
market rate of return minus the risk-free rate of return.
The slope of the security market line is the:
market risk premium.
If a firm accepts Project X it will not be feasible to also accept Project Z because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:
mutually exclusive.
To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.
risk-free rate
Expected return is the return on a _______ asset expected in the future.
risky
The ________ is a positively sloped linear function that plots securities' expected returns against their betas.
security market line
Most financial securities have some level of ________ risk.
systematic
A project has a net present value of zero. Given this information:
the project's cash inflows equal its cash outflows in current dollar terms.
To determine a firm's cost of capital, one must include:
the returns currently required by both debtholders and stockholders.
Assume a firm utilizes the security market line approach to determine the cost of equity. If the firm currently pays an annual dividend of $2.40 per share and has a beta of 1.42, all else constant, which of the following actions will decrease the firm's cost of equity?
A decrease in the firm's beta
Which of the following items are included when calculating the expected return on a portfolio? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy
I, II, III, and IV
Which of the following are assumptions of the capital asset pricing model (CAPM)? I. A risk-free asset has no systematic risk. II. Beta is a reliable estimate of total risk. III. The reward-to-risk ratio is constant. IV. The market rate of return can be approximated.
I, III, and IV only
According the video, one of the biggest challenges for the Net Present Value method is:
Identifying the appropriate discount rate to use.
Which of the following statements regarding a firm's pretax cost of debt is accurate?
It is based on the current yield to maturity of the company's outstanding bonds.
Which of the following statements regarding the weighted average cost of capital is accurate?
It is the return investors require on the total assets of the firm.
An investor wants to reduce the unsystematic risk in her portfolio. Which of the following actions is least likely to do so?
Reducing the number of stocks held in her stock portfolio
Which of the following statements best describes the principle of diversification?
Spreading an investment across many diverse assets will eliminate some of the total risk.
All of the following are disadvantages of the Payback Period, except:
The method incorporates the time value of money.
The Capital Asset Pricing Model (CAPM) shows that the expected return for a particular asset depends on all of the following, except:
The return on a risk-less asset
Which of the following is the main advantage of using the dividend growth model to estimate a firm's cost of equity?
The simplicity of the model.
The internal rate of return is defined as the:
discount rate which causes the net present value of a project to equal zero.
The required return of preferred stock is equal to the ________ ________ on the preferred stock.
dividend yield
While evaluating a stock, you estimate that it will earn a return of 11 percent if economic conditions are favorable, and 3 percent if economic conditions are unfavorable. Given the probabilities of favorable versus unfavorable economic conditions, you conclude that the stock will earn 7.2 percent next year. The 7.2 percent figure is called the:
expected return
T or F: Since preferred stock has a fixed dividend paid every period forever, it is essentially a perpetuity.
true
Which of the following statements regarding the cost of preferred stock is accurate?
It equals the dividend yield.
A ________ is the market's measure of systematic risk.
beta of 1
Which of the following statements is true of a portfolio's standard deviation?
It can be less than the standard deviation of the least risky security in the portfolio.
With respect to capital project analysis, which of the following statements is accurate?
Overall, a company makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
What does mutually exclusive mean?
Taking one project means that we cannot take the other.
Which one of the following statements related to the internal rate of return (IRR) is correct?
The IRR is equal to the required return when the net present value is equal to zero.
The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?
The actual expected stock return indicates the stock is currently overpriced.
The Payback Period Rule states that a company will accept a project if:
The calculated payback is less than a pre-specified number of years.
When choosing between mutually exclusive projects, what is the best method to use?
The highest NPV is always the best option.
The security market line is a positively sloped straight line that displays the relationship between expected return and ____________.
beta
Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the:
cost of debt.
Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the:
cost of equity.
The Average Accounting Return (AAR) Rule states that a company will accept a project that has an average account return that:
exceeds a pre-determined target average accounting return.
T or F: The cost of capital depends primarily on the source of the funds, not the use.
false
T or F: The coupon rate on the firm's outstanding debt can be used as a substitute for the cost of debt.
false
The percent of investment that the project costs can be referred to as all of the following, except:
free cash flow
The length of time a firm must wait to recoup the money it has invested in a project is called the:
payback period.
Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n):
portfolio
The cost of preferred stock is equivalent to the:
rate of return on a perpetuity.
T or F: Risk-free assets have a beta of 0 and the market portfolio has a beta of 1.
true
The Internal Rate of Return (IRR) represents which of the following:
The discount rate that makes the net present value equal to zero.
According to the video, which of the following are disadvantages of the Average Accounting Return (AAR)?
Time value of money is ignored. An arbitrary benchmark cutoff rate is established. Market values are not considered. All of the above.
Rafia owns stocks of 15 different companies. Together, the stocks have a value of $78,640. Twelve percent of that total value is from one company, Gambrell & Valdez. The twelve percent figure is called a(n):
portfolio weight
Portfolio Beta is the ______________ average of the Betas of the investments included in the portfolio.
weighted
The expected return of a stock, based on the likelihood of various economic outcomes, equals the:
weighted average of the returns for each economic state.
