FIN 3403 Exam 3 sample questions
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 commences selling puzzles B is the correct answer.
Which one of the following statements related to unexpected returns is correct?
A. All announcements by a firm affect that firm's unexpected returns. B. Unexpected returns over time have a negative effect on the total return of a firm. C. Unexpected returns are relatively predictable in the short-term. D. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term. E is the correct answers.
Which one of the following statements is correct concerning unsystematic risk?
A. An investor is rewarded for assuming unsystematic risk. B. Eliminating unsystematic risk is the responsibility of the individual investor. C. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. D. Beta measures the level of unsystematic risk inherent in an individual security. E. Standard deviation is a measure of unsystematic risk. B is the correct answer
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. Profits are removed as a market incentive when markets become efficient. D is the correct answer.
When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I. differing productive lives II. differing manufacturers III. required replacement at end of economic life IV. differing initial cost
A. I and II B. I and III C. I and IV D. II and IIII E. II and IV B is the correct answer.
Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to the project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals.
A. I and II only B. II and III only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV E is the correct answer.
The equivalent annual cost considers which of the following? I. required rate of return II. operating costs III. need for replacement IV. economic life
A. I and II only B. II and IV only C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV E is the correct answer.
Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary
A. I and II only B. III and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV C is the correct answer.
The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.
A. I and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV D is the correct answer.
Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable 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 A is the correct answer
Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.
A. I and III only B. II and IV only C. I and IV only D. I, II and III only E. I, II, III, and IV D is the correct answer
Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient.
A. I and III only B. II and IV only C. I and IV only D. I, III, and IV only E. I, II, and III only E is the correct answer.
The expected return on a portfolio considers which of the following factors? 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
A. I and III only B. II and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV E is the correct answer.
Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV. toymakers are required to improve their safety standards
A. I and III only B. II and IV only C. II and III only D. I and IV only E. I, III, and IV only D is the correct answer
Which one of the following statements is correct concerning market efficiency?
A. Real asset markets are more efficient than financial markets. B. If a market is efficient, arbitrage opportunities should be common. C. In an efficient market, some market participants will have an advantage over others. D. A firm will generally receive a fair price when it issues new shares of stock. E. New information will gradually be reflected in a stock's price to avoid any sudden change in the price of the stock. D is the correct answer.
Which one of the following statements related to risk is correct?
A. The beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio. B. Every portfolio that contains 25 or more securities is free of unsystematic risk. C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio. D. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta. E. Stocks that move in tandem with the overall market have zero betas. C is the correct answer
Which one of the following statements is correct?
A. The greater the volatility of returns, the greater the risk premium. B. The lower the volatility of returns, the greater the risk premium. C. The lower the average return, the greater the risk premium. D. The risk premium is unrelated to the average rate of return. E. The risk premium is not affected by the volatility of returns. A is the correct answer.
Which one of the following statements concerning scenario analysis is correct?
A. The pessimistic case scenario determines the maximum loss, in current dollars, that a firm could possibly incur from a given project. B. Scenario analysis defines the entire range of results that could be realized from a proposed investment project. C. Scenario analysis determines which variable has the greatest impact on a project's final outcome. D. Scenario analysis helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions. E. Management is guaranteed a positive outcome for a project when the worst case scenario produces a positive NPV. D is the correct answer.
Which one of the following statements is correct?
A. The unexpected return is always negative. B. The expected return minus the unexpected return is equal to the total return. C. Over time, the average return is equal to the unexpected return. D. The expected return includes the surprise portion of news announcements. E. Over time, the average unexpected return will be zero. E is the corrrect answer
The systematic risk of the market is measured by:
A. a beta of 1.0. B. a beta of 0.0. C. a standard deviation of 1.0. D. a standard deviation of 0.0. E. a variance of 1.0. A is the correct answer
The return earned in an average year over a multi-year period is called the _____ average return.
A. arithmetic B. standard C. variant D. geometric E. real A is the correct answer.
The average compound return earned per year over a multi-year period is called the _____ average return.
A. arithmetic B. standard C. variant D. geometric E. real D is the correct answer.
You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?
A. arithmetic return B. historical return C. expected return D. geometric return E. required return C is the correct answer.
Total risk is measured by _____ and systematic risk is measured by _____.
A. beta; alpha B. beta; standard deviation C. alpha; beta D. standard deviation; beta E. standard deviation; variance D is the correct answer
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. A is the correct answer
Net working capital:
A. can be ignored in project analysis because any expenditure is normally recouped at the end of the project. B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning of a project. C. is rarely affected when a new product is introduced. D. can create either a cash inflow or a cash outflow at time zero of a project. E. is the only expenditure where at least a partial recovery can be made at the end of a project. D is the correct answer.
Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?
A. capital asset pricing model B. time value of money equation C. unsystematic risk equation D. market performance equation E. expected risk formula A is the correct answer.
Which one of the following would make a project unacceptable?
A. cash inflow for net working capital at time zero B. requiring fixed assets that would have no salvage value C. an equivalent annual cost that exceeds that of an alternative project D. lack of revenue generation E. a depreciation tax shield that exceeds the value of the interest expense C is the correct answer.
The principle of diversification tells us that:
A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. B. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. C. spreading an investment across five diverse companies will not lower the total risk. D. spreading an investment across many diverse assets will eliminate all of the systematic risk. E. spreading an investment across many diverse assets will eliminate some of the total risk. E is the correct answer.
To convince investors to accept greater volatility, you must:
A. decrease the risk premium. B. increase the risk premium. C. decrease the real return. D. decrease the risk-free rate. E. increase the risk-free rate. B is the correct answer.
Scenario analysis is defined as the:
A. determination of the initial cash outlay required to implement a project. B. determination of changes in NPV estimates when what-if questions are posed. C. isolation of the effect that a single variable has on the NPV of a project. D. separation of a project's sunk costs from its opportunity costs. E. analysis of the effects that a project's terminal cash flows has on the project's NPV. B is the correct answer.
Scenario analysis is best suited to accomplishing which one of the following when analyzing a project?
A. determining how fixed costs affect NPV B. estimating the residual value of fixed assets C. identifying the potential range of reasonable outcomes D. determining the minimal level of sales required to break-even on an accounting basis E. determining the minimal level of sales required to break-even on a financial basis C is the correct answer.
The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.
A. efficient markets hypothesis B. systematic risk principle C. open markets theorem D. law of one price E. principle of diversification B is the correct answer
The expected risk premium on a stock is equal to the expected return on the stock minus the:
A. expected market rate of return. B. risk-free rate. C. inflation rate. D. standard deviation. E. variance. B is the correct answer.
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 C is the correct answer.
Which one of the following best describes pro forma financial statements?
A. financial statements expressed in a foreign currency B. financial statements where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales C. financial statements showing projected values for future time periods D. financial statements expressed in real dollars, given a stated base year E. financial statements where all accounts are expressed as a percentage of last year's values C is the correct answer.
An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.
A. forecasting B. combined C. complex D. simulation E. break-even D is the correct answer.
An analysis of the change in a project's NPV when a single variable is changed is called _____ analysis.
A. forecasting B. scenario C. sensitivity D. simulation E. break-even C is the correct answer.
The expected return on a stock computed using economic probabilities is:
A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you should anticipate as long as the economic forecast remains constant. D is the correct answer
The expected return on a stock given various states of the economy is equal to the:
A. highest expected return given any economic state. B. arithmetic average of the returns for each economic state. C. summation of the individual expected rates of return. D. weighted average of the returns for each economic state. E. return for the economic state with the highest probability of occurrence. D is the correct answer.
Which one of the following is an example of unsystematic risk?
A. income taxes are increased across the board B. a national sales tax is adopted C. inflation decreases at the national level D. an increased feeling of prosperity is felt around the globe E. consumer spending on entertainment decreased nationally E is the correct answer
Which one of the following is the best example of a diversifiable risk?
A. interest rates increase B. energy costs increase C. core inflation increases D. a firm's sales decrease E. taxes decrease D is the correct answer
Which one of the following is an example of systematic risk?
A. investors panic causing security prices around the globe to fall precipitously B. a flood washes away a firm's warehouse C. a city imposes an additional one percent sales tax on all products D. a toymaker has to recall its top-selling toy E. corn prices increase due to increased demand for alternative fuels A is the correct answer.
Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2010? Rank from highest to lowest.
A. large company stocks, U.S. Treasury bills, long-term government bonds B. small company stocks, long-term corporate bonds, large company stocks C. small company stocks, long-term corporate bonds, intermediate-term government bonds D. large company stocks, small company stocks, long-term government bonds E. intermediate-term government bonds, long-term corporate bonds, U.S. Treasury bills C is the correct answer.
As the degree of sensitivity of a project to a single variable rises, the:
A. less important the variable to the final outcome of the project. B. less volatile the project's net present value to that variable. C. greater the importance of accurately predicting the value of that variable. D. greater the sensitivity of the project to the other variable inputs. E. less volatile the project's outcome. C is the correct answer.
Which type of analysis identifies the variable, or variables, that are most critical to the success of a particular project?
A. leverage B. risk C. break-even D. sensitivity E. cash flow D is the correct answer.
Forecasting risk emphasizes the point that the correctness of any decision to accept or reject a project is highly dependent upon the:
A. method of analysis used to make the decision. B. initial cash outflow. C. ability to recoup any investment in net working capital. D. accuracy of the projected cash flows. E. length of the project. D is the correct answer.
A stock with an actual return that lies above the security market line has:
A. more systematic risk than the overall market. B. more risk than that warranted by CAPM. C. a higher return than expected for the level of risk assumed. D. less systematic risk than the overall market. E. a return equivalent to the level of risk assumed. C is the correct answer
Simulation analysis is based on assigning a _____ and analyzing the results.
A. narrow range of values to a single variable B. narrow range of values to multiple variables simultaneously C. wide range of values to a single variable D. wide range of values to multiple variables simultaneously E. single value to each of the variables D is the correct answer.
Estimates of the rate of return on a security based on a 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; accurately B is the correct answer.
A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?
A. portfolio B. nondiversifiable C. market D. unsystematic E. total D is the correct answer.
Sensitivity analysis determines the:
A. range of possible outcomes given that most variables are reliable only within a stated range. B. degree to which the net present value reacts to changes in a single variable. C. net present value range that can be realized from a proposed project. D. degree to which a project relies on its fixed costs. E. ideal ratio of variable costs to fixed costs for profit maximization. B is the correct answer.
Which one of the following is least apt to reduce the unsystematic risk of a portfolio?
A. reducing the number of stocks held in the 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 A is the correct answer
The excess return is computed as the:
A. return on a security minus the inflation rate. B. return on a risky security minus the risk-free rate. C. risk premium on a risky security minus the risk-free rate. D. the risk-free rate plus the inflation rate. E. risk-free rate minus the inflation rate. B is the correct answer.
Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?
A. reward-to-risk matrix B. portfolio weight graph C. normal distribution D. security market line E. market real returns D is the correct answer
Which one of the following is represented by the slope of the security market line?
A. reward-to-risk ratio B. market standard deviation C. beta coefficient D. risk-free interest rate E. market risk premium E is the correct answer.
Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return?
A. risk premium B. geometric return C. arithmetic D. standard deviation E. variance A is the correct answer.
Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. Which one of the following terms best defines that market?
A. riskless market B. evenly distributed market C. zero volatility market D. Blume's market E. efficient capital market E is the correct answer.
Which one of the following types of analysis is the most complex to conduct?
A. scenario B. break-even C. sensitivity D. degree of operating leverage E. simulation E is the correct answer.
Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using?
A. simulation testing B. sensitivity analysis C. break-even analysis D. rationing analysis E. scenario analysis E is the correct answer.
Forecasting risk is defined as the possibility that:
A. some proposed projects will be rejected. B. some proposed projects will be temporarily delayed. C. incorrect decisions will be made due to erroneous cash flow projections. D. some projects will be mutually exclusive. E. tax rates could change over the life of a project. C is the correct answer.
Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?
A. storing supplies in the same space currently used for materials storage B. utilizing the basket manager to oversee wreath production C. hiring additional employees to handle the increased workload should the firm accept the wreath project D. researching the market to determine if wreath sales might be profitable before deciding to proceed E. planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding debt C is the correct answer.
Decreasing which one of the following will increase the acceptability of a project?
A. sunk costs B. salvage value C. depreciation tax shield D. equivalent annual cost E. accounts payable requirement D is the correct answer.
Which one of the following risks is irrelevant to a well-diversified investor?
A. systematic risk B. unsystematic risk C. market risk D. nondiversifiable risk E. systematic portion of a surprise B is the correct answer.
Efficient financial markets fluctuate continuously because:
A. the markets are continually reacting to old information as that information is absorbed. B. the markets are continually reacting to new information. C. arbitrage trading is limited. D. current trading systems require human intervention. E. investments produce varying levels of net present values. B is the correct answer
Systematic risk is measured by:
A. the mean. B. beta. C. the geometric average. D. the standard deviation. E. the arithmetic average. B is the correct answer
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. A is the correct answer
Which one of the following is a risk that applies to most securities?
A. unsystematic B. diversifiable C. systematic D. asset-specific E. total C is the correct answer.
Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?
A. variance B. standard deviation C. reward-to-risk ratio D. beta E. risk premium C is the correct answer
Which one of the following is most directly affected by the level of systematic risk in a security?
A. variance of the returns B. standard deviation of the returns C. expected rate of return D. risk-free rate E. market risk premium C is the correct answer
Sensitivity analysis is based on:
A. varying a single variable and measuring the resulting change in the NPV of a project. B. applying differing discount rates to a project's cash flows and measuring the effect on the NPV. C. expanding and contracting the number of years for a project to determine the optimal project length. D. the best, worst, and most expected situations. E. various states of the economy and the probability of each state occurring. A is the correct answer.
If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace.
A. weak B. semiweak C. semistrong D. strong E. perfect A is the correct answer
You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.
A. weak B. semiweak C. semistrong D. strong E. perfect C is the correct answer.
The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.
A. weak B. semiweak C. semistrong D. strong E. perfect D is the correct answer.
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. D is the correct answer.
The equivalent annual cost method is useful in determining:
A. which one of two machines to purchase if the machines are mutually exclusive, have differing lives, and are a one-time purchase. B. the tax shield benefits of depreciation given the purchase of new assets for a project. C. the operating cash flows of a cost-cutting project. D. which one of two investments to accept when the investments have different required rates of return. E. which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out. E is the correct answer.
Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product
II, III and IV only
The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?
Stand-Alone Principle
Define and explain the three forms of market efficiency
Weak form efficiency - all historical information semistrong form efficiency - all public and historical information strong from efficiency - all private, public, and historical information
Changes in the net working capital requirements:
can affect the cash flows of a project every year of the projects life
Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision?
equivalent annual cost
The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?
incremental
The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:
incremental cash flows
The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following?
opportunity cost
G & L Plastic Molders 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?
sunk
Which one of the following costs was incurred in the past and cannot be recouped?
sunk
A company that utilizes the MACRS system of depreciation:
will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.