FIN320F Exam 2 - Smart Book Shannon_Dyer66, Finance Unit 10 - Unit 15, FIN 320F Exam 2 Vocabulary heatherkray, Finance 320F Final Exam Terms JMonroe55, FIN 320F Final (Units 10-15) KirstenTerry23

Suppose a project's operating cash flow is $150. The firm anticipates a $30 investment in net working capital and $80 in capital spending. What is the projects' cash flow?

$40 150-(30+80) = 40

What is the NPV of a project with in initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%

$5.94

What is the depreciation tax shield if EBIT is $600, depreciation is $1800, and the tax rate is 30%

$540 $1800 x .3 = $540

If a firm's variable cost per unit estimate used in its base case analysis is $50 per unit and they anticipate the upper and lower bounds to be +/- 10%, what is the "worst case" for variable cost per unit?

$55 1.10 x $50 = $55 Worst case for costs is always higher

Given the Following Data, what is the operating cash flow? EBIT = $80 Depreciation = $20 Taxes = $30

$70 EBIT+Depreciation-Taxes

Including preferred stock in the WACC formula adds which term if P is the market value of preferred stock and Rp is the cost of preferred?

(P/V) x Rp

pure play method

-Identify a publicly-traded firm that is a pure play firm for the project being considered -Determine this firm's risk-reduction characteristics -Use these elements to develop a discount rate for the project

By definition, what is the beta of the average asset equal to?

1

If PI > ____, then the project is acceptable

1

beta of an economy is _____

1 high beta is above 1

parts of BOP

1. Current account 2. Capital account 3. Official reserves account 4. Statistical discrepancies

components of cash flow from assets

1. Operating cash flow 2. Capital spending 3. Additions to net working capital

three managerial decisions

1. Product-what product or service the firm is going to sell 2. Production-how and how much to pay 3. Financing-how to pay for new projects

Arrange the following investment from lowest historical risk premium to highest historical risk premium Large Company Stocks US Treasury Bills Small Company Stocks Long-term Corporate Bonds

1. US Treasury Bills 2. Long-term Corporate Bonds 3. Large-Company Stocks 4. Small-Company Stocks

Three functions of money:

1. exchange 2. prices 3. store of value

5 rules for capital budgeting:

1. include only cash flows 2. include the impact of the project on cash flows from other product line 3. include all opportunity costs (even if a company owns an asset, if that asset was to be used for a project, it should be included in the project evaluation) 4. forget sunk costs 5. include only after-tax cash flow in your cash flow calculation

If an analyst's forecast for a firm's earning growth is 7%, and its dividend yield is 3%, it's cost of equity will be ____________.

10% 3+7

What is the total return for a stock that currently sells for $100, is expected to pay a dividend in one year of $2, and has a constant growth rate of 8%?

10% R = ($2/$100)+0.08 = 10%

If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be ....

100% Reversed

What is the total return for a stock that currently sells for $50, just paid a $1.75 dividend, and has a constant growth rate of 8%?

11.78% R - ($1.75 x (1.08)/$50)+0.08 = 11.78

What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4% and the expected return on the market is 12%.

13.6 4% + 1.2(12%-4%) = 13.6%

One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?

15% ($114-100+1)/$100 = 15%

If stock ABC has a mean return of 10% with a standard deviation of 5%, then the probability of earning a return greater than 15% is about ____________%.

16%

The rules for depreciating assets for tax purposes are based upon provisions in the:

1986 Tax Reform Act

What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%

2.91 =PV(future cash flows)/Initial Cost = ((80/1.12)+ (20/1.12^2))/30

A zero-growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be?

20.00 P0 = $2/0/10 = $20

ABC has a beta of 2.5 and XYZ has a beta of 1.5. The risk-free rate is 4% and the market risk premium is 9%. What is the expected return on a portfolio that is equally invested in ABC and XYZ?

22%

If Joan owns 100 shares of ABC company and the company is electing 4 directors, under cumulative voting, Joan would usually have ______ votes.

400

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.70%

Special situations while making capital budgeting decision:

> economically independent projects (involves accept/reject decision) > mutually exclusive projects (involves ranking decision) > capital rationing (happens when there isn't enough capital to take all wealth-increasing projects)

categories of cash flows:

> incremental cash flow after-tax (ICFAT) > free cash flow (FCF) (distributable cash flow)

types of cash flows:

> initial cf > operating cf > terminating cf

soft rationing:

> limit on investments are put by the managers for better control of the firm. limit growth to a manageable level and existing owners doesn't want to dilute their control of the company by issuing additional financial securities.

The NYSE differs from the NASDAQ primarily because the NYSE has: brokers a faster network a face-to-face auction market a physical location

A Face-to-Face Auction Market A Physical Location

What is a Eurobond?

A bond issued in multiple countries but denominated in a single currency

Standard deviation

A common measure used to measure the risk of a probability distribution, it is the

Security market line (SML)

A straight line that is the graph of the CAPM. It specifies a linear relationship between the risk premium of a security and its beta with the market portfolio.

Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

A toy store that sells online only

Preferred stock

A type of stock whose holders are given certain priority over common stockholders in the payment of dividends. Usually the dividend rate is fixed at the time of issue and no voting rights are given.

Electronic communications network (ECN)

A type of website that allows investors to trade directly with one another.

Electronic communications network (ECN).

A type of website that allows investors to trade directly with one another.

Portfolio expected return

A wealth-weighted average of the returns of the assets held in the portfolio.

Portfolio variance

A wealth-weighted sum of the covariances and variances of the assets held in the portfolio.

What can we say about the dividends paid to common and preferred stockholders?

Dividends to common stockholders are not fixed Dividends to preferred stockholders are fixed

Websites that allow investors to trade directly with one another are termed _______.

ECNs

________ones when making one choice is independent of other choices. For example, this month you purchase a refrigerator and a car. Your purchase of a refrigerator is independent of your auto purchase. Capital budgeting for independent projects involves an accept/reject decision.

Economically Independent Projects

The return an investor in a security receives is ___________ ____________ the cost of the security to the company that issued it.

Equal To

The possibility that errors in projected cash flows will lead to incorrect decisions is known as: Estimation Risk Guess and Bless Forecasting Risk Managerial Incompetence

Estimation Risk Forecasting Risk

The natural consequences of international operations in a world where relative currency values move up and down is called _______.

Exchange Rate Risk

An interest rate swap involves swapping a _______ payment for a __________ payment.

Floating Rate; Fixed Rate Fixed Rate; Floating Rate

Net Present Value (NPV)

NPV is a dollar measure of the impact of a project on the company's wealth. It uses the opportunity cost to bring all of the project's incremental cash flows back to the present and then compares inflows to outflows to see if the project is acceptable.

_______________ decision rule is to accept the project with the lowest value.

Net Present Cost (NPC) NPC = PV (outflow)

In capital budgeting, ___________ determines the dollar value of a project to the company.

Net Present Value

______is a dollar measure of the impact of a project on the company's wealth. It uses the opportunity cost to bring all of the project's incremental cash flows back to the present and then compares inflows to outflows to see if the project is acceptable.

Net Present Value (NPV)

The difference between a firm's current assets and its current liabilities is known as the _____________.

Net Working Capital

Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive?

Net present value

If a company's growth for years 1 through 3 is 20% but stabilizes at 5% beginning in year 2, its growth pattern would be described as ______

Non-Constant

Systematic risk will ______ when securities are added to a portfolio

Not Change

Which of the following is an example of an opportunity cost? Rental income likely to be lost by using a vacant building for an upcoming project Lowering taxes by increasing depreciation expenses Money spent on advertising to take advantage of opportunities in the market

Rental income likely to be lost by using a vacant building for an upcoming project

The following are disadvantages of the SML approach

Requires estimation of beta Requires estimation of the market risk premium

Political risk

Risk related to changes in value that arise because of political actions.

What is the equation for finding the cost of preferred stock?

Rp=D/P0

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

Scenario Analysis or Asking What-If Questions

Market risk premium

Slope of the security market line; the difference between the expected return on a market portfolio and the risk-free rate.

Which one of the following is the most apt to have the largest risk premium in the future based on the historical record for 1926-2014?

Small-company stocks

Principle of diversification

Spreading an investment across many assets will eliminate some of the risk of the portfolio.

According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm"

Stand-Alone

Private equity firms provide financing for firms that otherwise would have difficulty raising capital such as:

Start-up firms, Distressed Firms, Closely held Private Firms

Stated value

Stated liquidating value, usually $100

Efficient Market Hypothesis (EMH)

States that prices of securities fully reflect available information. Investors buying bonds and stocks should expect to obtain an equilibrium rate of return. Firms should expect to receive the fair value for the securities they sell.

Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond? Dividends are unknown but certain Different stock issues have different maturity dates Stock has no set maturity Dividends are unknown and uncertain The required rate of return is unobservable

Stock has no set maturity Dividends are unknown and uncertain The required rate of return is unobservable

Common stock

Stock that has no special preference in receiving dividends or in bankruptcy

inflation

decrease in purchasing power of a currency over a given time period; more common

debit transaction

decrease in wealth; gives rise in supply for money; created by import of goods and services or decrease in liabilities

Increase in the purchasing power of a currency is called ________

deflation feared by central bankers because it slows down economic activity since it encourages customers to delay purchases.

option

derivative contract that gives the buyer a right to buy/sell an asset; creates very one-sided risk relationship; often has an expiration date

initial cf is divided into:

direct and indirect expenditure

Direct expenditures

directly connected with obtaining the capital asset.

___________________ is a list of possible outcomes and their likelihoods

discrete probability distribution

variance

dispersion of possible returns around expected return; equal to the addition of market risk and diversifiable risk; squaring this produces the standard deviation

two types of risk with portfolios:

diversifiable risk and market risk/systematic risk diversification reduces diversifiable risk(unique risk) market risk is not affected by diversification

PI should be used to make decision for ________ projects.

divisible

registration statement

document required by the SEC for new public issues that constrains the issuing firm's financial information, financial history, and details of the existing business

long-position exchange rates

dollar cash flow is directly correlated with the value of foreign currency

short-position exchange rates

dollar cash flow is inversely correlated with the value of the real

Kondratieff Wave

economy follows a long pattern of growth and decline over approximately 50 year periods

The view that the market price reflects information about the asset is

efficient market hypothesis

We have to compare mutually exclusive projects with __________ lives

equivalent

profits are magnified by the use of ___________ operating costs.

fixed FC over VC for profit

financial leverage

fixed interest rate is used to magnify a change in operating income into a change in net income; involves the addition of the use of debt for the financing of a firm

_________ costs do not vary with the level of sales, an increase in sales lowers the ___________ cost per unit.

fixed, fixed

Floor Broker.

he DMM works with brokers, who go to the exchange on behalf of their customers who wish to buy or sell financial securities. The broker does not own the security but acts as an agent and received a commission for the service. (Similar to a real estate broker. The broker doesn't own houses, but rather acts as the agent for someone wishing to sell a house. The broker gets a commission if the sale goes through. Same process for someone wanting to buy or sell stock.)

Dividend yield:

he expected annual dividend of the stock divided by its current price.

Cumulative dividend.

he type of dividend on preferred stock that takes priority over dividend payments on common stock. Dividends may not be paid on the common stock until all past dividends on the preferred stock have been paid.

The basic NPC investment rule is: (select all that apply) accept a project if the NPV is less than zero accept a project if the discount rate is above zero if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference reject a project if its NPV is less than zero accept a project if the NPV is greater than zero

if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference reject a project is its NPV is less than zero accept a project if the NPV is greater than zero

deflation

increase in purchasing power of a currency over a given time period; lowers economic activity by increasing the real burden of debt and encouraging consumers to delay purchases; feared by central bankers

credit transaction

increase in wealth; gives rise in demand for dollars; created by exports of goods or services or increase in liabilities

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

increase the risk level of the firm over time.

In an efficient market, the cost of equity for a highly risky firm:

increases in direct relation to the stock's systematic risk

capital budgeting analysis evaluates the _______________ cash flows.

incremental after-tax

market makers

individuals and firms that assist other in completing market transactions

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because _________.

it defines the business of the firm

risk is measure by beta because market is mostly determined by __________________

large investors

break-even profit

level of sales at which a project goes from loss to profit; calculate by dividing total fixed costs by the contribution margin

A firm that practices financial and operating leverage is called ___________ firm

levered

with ___________ investment funds, PI should be used for decision making because each dollar should be used to produce the greatest wealth increase.

limited

the ranking decision with capital rationing is caused by _____________

limits on available investment capital

Soft Rationing

limits on investments are made by a firm's managers for better control of the firm

companies that produce items with a steady demand will have __________ beta

lower

Deflation

lowers economic activity by increasing the real burden of debt and encouraging consumers to delay purchases

the beta of a risky portfolio cannot be less than __________ nor greater than ___________

lowest individual beta in the portfolio, highest individual beta in the portfolio

capital assets

major investments that are long-lived, expensive, and difficult to unwind so require a formal decision process and economic evaluation tools

economically independent project

making one choice is independent of other choices; involves an accept/reject decision

Primary market

market where corporations, with the assistance of investment banks, create financial securities and issue them to the investing public. This is how companies raise capital.

Secondary market

market where, once issued, securities are traded among investors. The company is not involved with secondary market transactions. Note, primary and secondary markets are functions within the stock market, not separate markets.

derivative markets

markets that support trade in derivative securities, financial securities, whose value is derived from the value of an underlying asset

direct financing

markets where companies issue financial securities to expand and build their operations

Decision Rules

maximize total NPV while staying within the capital budget

payback

measures the time necessary for a project to return to its initial investment; focuses on liquidity; cost of project/annual cash flow; ignores time value and risk; doesn't address impact an investment will have on value of stock and ignores cash flows after the cutoff date

net present value (NPV)

measures the wealth increase of a project and dollar measure of desirability; considers the magnitude, timing, and risk of the project's cash flows; difference between an investment's market value and its cost

Private equity financing AFTER ground floor financing is termed _________________ financing

mezzanine

cost of capital

minimum acceptable rate of return a project must earn--the project's opportunity cost

cost of capital

minimum required return on a new investment; the discount rate used to evaluate capital budgeting projects; minimum acceptable rate of return a project must earn; project's opportunity cost; depends primarily on the use of funds, not the source

eurocurrency

money deposited in a financial center outside of the country whose currency is involved

Golden Cross

moving averages; movement of short-run average above the long-run average, which in turn reflects increased market confidence

The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as:

multiple rates of return.

Operating Cash Flows

must evaluate the operating characteristics of projects

PI and IRR will differ from NPV ranking for __________

mutually exclusive projects with differing magnitude or differing timing of cash flow

ranking decision with capital rationing

not due to the nature of the projects, but due to limits on available investment capital.

hard-rationing

occurs when funds are not available and managers must choose the "best"

hard rationing

occurs when funds are unavailable and managers have to choose the best option.

soft-rationing

occurs when limits on investments are made by a firm's managers for better control of the firm; limit growth to manageable level and don't want to issue additional financial securities

economic interdependence

occurs when the project may increase or decrease the cash flows in other parts of the company

Capital gain/loss

occurs when the value of your asset changes.

Ed owns a store that caters primarily to men. Each of the answer options represents an item related to a planned store expansion. Each of these items should be included in the expansion analysis with the exception of the cost:

of the blueprints that have been drawn of the expansion area.

efficient market hypothesis (EMH)

organized around three classes of information: 1) historic information, 2) public information and 3) private information

exchanges

organized markets where companies can facilitate the trade of financial assets

dealer

owns the assets during the process; makes money only if proficient in pricing the securities

total economic lives doesn't matter when we compare projects on a ____________ basis

per-period The method used is called Equivalent Annual Cost (EAC). It uses time value to restate the time lines.

portfolio weight

percentage of a portfolio's total value in a particular asset

Incremental Cash Flows After Taxes (ICFAT)

periodic cash outflows and inflows that occur if, and only if, an investment project is accepted

incremental cash flows after taxes

periodic cash outflows and inflows that occur, if and only if, an investment project is accepted

two primary measure for inflation are:

prices and assets

____________ calculates wealth created per dollar invested.

profitability index

Mutually exclusive projects:

projects in which the acceptance of one excludes accepting the other projects.

erosion

reduction in the cash flows of existing operations

PI is a __________ measure.

relative

current account

represents non-financial transactions between a country and the rest of the world; also includes military transactions, performed services, factor income from investments, and unilateral transfers

realized return

return that is actually received at the end of the investment period

American Depositary Receipt

security issued in the U.S. that represents shares of a foreign stock, allowing it to be traded in the U.S.

the straight line connecting rf and rm is ____________

security market line (SML) return risk relationship

market-risk premium

slope of the security-market line

two possible capital rationing situations:

soft rationing and hard rationing

physical money made of gold and silver that has intrinsic value is called ___________

specie money

Government is ___________ borrowing cost

subsidizing

increasing cash flows in other parts of the company is called ______________

synergy

floating system of exchange

system in which exchange rates are set in markets by supply and demand

over-the-counter market

systems by which dealers can offer to buy and sell securities among themselves and to their customers

capital gains tax aka ____________________

tax credit

depreciation tax shield

tax saving that results from the depreciation deduction; calculated as depreciation multiplied by the corporate tax rate

A benchmark PE ratio can be determined using: the constant growth model the PEs of similar companies Bank of Canada estimates a company's own historical PEs

the PEs of similar companies a company's own historical PEs

expected return

the future, generally uncertain return that one expects to get from an investment; what's used to make/analyze decisions

cross rate

the implicit exchange between two currencies quoted in some third currency

The beta of a risky portfolio cannot be less than _____ nor greater than ____.

the lowest individual beta in the portfolio; the highest individual beta in the portfolio

the ranking decision with mutually exclusive project was caused by ________________

the nature of the projects

The market for venture capital refers to:

the private financial marketplace for new, high-risk firms

A firm's registration statement to issue-securities will typically include everything except:

the proposed price for the security

london interbank offered rate (LIBOR)

the rate most international banks charge one another for overnight eurodollar loans

accounting rate of return

the rate of return earned on a project. It is calculated by comparing the average net income earned by a project to the cost of the project, measured by the average book value

Internal rate of return (IRR).

the rate that causes the NPV of the project to be zero. The per-period rate earned on the project.

Profitability index:

the ratio of the present value of the future expected cash flows after initial investment divided by the amount of the initial investment.

efficient-market hypothesis

theory that market prices reflect information about the process; if many market participants seek out good information and they buy and sell based on that information, then the market price will reflect the true value

covariance

two assets with perfectly inversely correlated returns balance each other out and produce a very stable portfolio return

forward hedge

two-asset portfolio with a correlation coefficient of -1

The Capital Budgeting Process

used to guide capital expenditure decisions many companies make. This process consists of six steps or phases.

account rate of return (ARR)

uses the Average Accounting Net Income and Average Investment to determine a rate of return; average net income/average book value; disadvantage is that is uses book rather than market values

Bootstrapping

using personal savings, selling personal assets, borrowing against assets, using credit cards, and taking on personal loans to raise capital

variability of realized return aka __________

variance

A riskless investment has no ____________. the expected return will be same as the realized return.

volatility

The standard deviation measures the _____ of a security's returns over time.

volatility

increased leverage also means increased ___________

volatility

Weighted Average Cost of Capital (WACC)

weighted average of the cost of each capital component of a levered firm

weighted average cost of capital (WACC)

weighted average of the cost of each capital component of a levered firm; overall return the firm must earn on its existing assets to maintain the value of its stock

the __________ are the proportion of debt and equity used by the firm

weights

cash inflow

what the firm should account for if a project requires a lower working capital investment

cash outflow

what the firm should account for if a project requires a working capital investment

Capital Rationing

when a company has limited capital and cannot take on all wealth-increasing projects

Discount (to discount an announcement)

when an announcement has limited impact on a market price because the information was already embedded in the price. (already known)

Hard Rationing

when funds are not available and managers must choose the 'best' projects from among all available projects

Economically Independent Projects

when making one choice is independent of other choices

Economic interdependencies

when the project may increase the cash flows in other parts of the company also occur when the project decreases the cash flows in other parts of the company (erosion

Short-term operating expenses

where the benefits are enjoyed in the same period as the expense

barter

where the buyer and seller must negotate a swap of physical goods and sevices

forward trade

agreement to exchange currency at some time in the future

free cash flow

amount of cash generated by a company that is available to distribute to the firm's creditors and owner; not needed for short-term and long-term investments; interchangeable with net cash flow

stand-alone principle

applied when incremental cash flows for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project

Normal distribution

Symmetric bell-shaped frequency distribution that can be completely described by its mean and standard deviation.

Some important characteristics of the normal distribution are that it is:

Symmetrical & Bell-Shaped

___________________ risk is the only risk important to the well diversified investor.

Systematic

Which of the following types of risk is not reduced by diversification?

Systematic, or market risk

Beta tells us the amount of ___________ risk of an asset or portfolio relative to ____________.

Systematic; an average risky asset

Using a benchmark PE ratio against current earning yields a forecasted price called a ______ price.

Target

Operating Cash Flow is a Function of:

Taxes, Earnings Before Interest and Taxes (EBIT), Depreciation

The systematic risk principles argues that the market does not reward risks:

That are borne unnecessarily That are diversifiable

Average accounting return

The average project earnings after taxes and depreciation, divided by the average book value of the investment during its life.

Average accounting return:

The average project earnings after taxes and depreciation, divided by the average book value of the investment during its life.

Variance

The average squared deviation from the mean - in frequency distributions, the range of the dispersion of the observed returns from the average return - in probability distributions, the range of the dispersion of the realized values from the expected return.

The Production Decision

The costs for producing the product.

Correlation

The covariance of the returns divided by the standard deviation of each return; a measure of the common variability shared by assets.

Which of the following are weaknesses of he payback method?

The cutoff date is arbitrary Time value of money principles are ignored Cash flows received after the payback period are ignored.

Short-run exposure

The day-to-day fluctuations in exchange rates create short-run risks for international firms.

Innovation/Surprise

The difference between the actual return from what was expected, caused by new information that was unanticipated.

Currently, the spot exchange rate for the Swiss franc is SF 1 = $1.10 or SF 1 = $1.12 90 days forward. What is true?

The dollar is selling at a discount to the Swiss franc The Swiss franc is at a forward premium

Translation exposure

The effect of an unanticipated change in the exchange rates on the consolidated financial statements of a multinational corporation (MNC).

Risk premium

The excess return on a risky asset that is the difference between expected return on the asset and the return on the risk-free asset.

Risk Premium

The excess return required from an investment in a risky asset over that required from a risk-free investment

Spot exchange rate

The exchange rate on a spot trade.

Systematic risk principle

The expected return on a risky asset depends only on that asset's systematic risk.

A security has a beta of 1, a market risk premium of 8%, and a risk-free rate of 3%. What will happen to the expected return if the beta doubles?

The expected return will increase to 19% from 11% Old Expected Return is 3%+1x8%=11% New Expected Return is 3%+2x8%=19%

What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level

The firm itself becomes riskier It accepts projects it should reject It rejects projects it should accept

Red herring

The first document released by an underwriter of a new issue to prospective investors.

Order flow.

The flow of customers' orders to buy and sell stocks

Order flow

The flow of customers' orders to buy and sell stocks.

Portfolio weights

The fraction of the total investment in a portfolio held in each individual investment in the portfolio.

Return on investment

The gain (or loss) from an asset.

g.

The growth rate of dividends.

Cross rate

The implicit exchange rate between two currencies (usually non-U.S.) quoted in some third currency (usually the U.S. dollar).

What is a cross-rate?

The implicit exchange rate between two currencies quoted in a third currency

Fisher effect

The real rate of interest is invariant to the rate of inflation. Investors demand an inflation premium to compensate them for the loss of purchasing power.

Real interest rate

The real rate of return adjusted for inflation. The compensation investors demand for foregoing the use of their money.

Inflation

The reduction in a currency's purchasing power over time.

Risk-free rate of return

The return on an asset with no default risk. Generally measured using U.S. Treasury instruments - proxy for the pure time value of money

Cost of equity

The return that equity investors require on their investment in the firm.

Return on Equity.

The return to shareholders on their investment in the company

Announcement

The revelation of information to the market.

The Product Decision

The revenue the product will produce

Exchange rate risk

The risk related to having international operations in a world where relative currency values vary.

According to the CAPM, what is the expected return on a stock if its beta is equal to zero?

The risk-free rate

What is the intercept of the security market line (SML)?

The risk-free rate

According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?

The risk-free rate of return

Standard deviation

The square root of the variance - the standard statistical measure of the spread of a sample - unlike the variance, which is measured in squared percent, the SD is in measured in percent

Nominal interest rate

The stated rate at which money will grow

Portfolio beta

The sum of the betas of each asset in a portfolio multiplied by the percent weight of each asset in the portfolio.

Total return:

The sum of the dividend yield and the capital gain yield.

Arithmetic average

The sum of the values observed divided by the total number of observations—sometimes referred to as the mean.

Depreciation tax shield

The tax savings that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate. Depreciation, even though it is not a cash flow, is included in capital budgeting because it affects taxes, which are a cash flow.

DMM's Post

The trading stations on the floor of the exchange from which DMMs operate. We have an old post in the Hall of Honors.

DMM's Post.

The trading stations on the floor of the exchange from which DMMs operate. We have an old post in the Hall of Honors.

Weighted average cost of capital (WACC)

The weighted average of the cost of equity and the after-tax cost of debt.

How are the unsystematic risks of two different companies in two different industries related?

There is no relationship

True or False: Net Working Capital will be recovered at the end of a project.

True

True or False: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return

True

True or False: a project with non-conventional cash flows will produce two or more IRRs

True

True/False: To prepare proforma financial statements, estimates of quantities such as unit sales, selling price per unit, variable cost per unit, and total fixed costs are required

True

When using the pure play approach for a proposed investment, a firm is primarily seeking a rate of return that:

best matches the risk level of the proposed investment.

__________ coefficient measures market risk of an asset relative to the variability of the economy.

beta

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the

beta coefficient.

In a ________ market, the managerial focus is to keep the _________ high.

bull, rate of return

Payback

calculates the amount of time it takes for a project to "payback" its initial investment

discounted cash flow valuation

calculating the present value of a future cash flow to determine its value today

Dividends paid to common stockholders _________ be deducted from the payer's taxable income for tax purposes

cannot

The process of planning and managing a firm's long-term investments is called __________________

capital budgeting

_______________ tax is levied on the difference between the price you pay for an asset and the price at which you sell the asset.

capital gains

Mutually Exclusive Projects

choosing from among alternatives and can pick only the best one

mutually exclusive project

choosing from among alternatives and then pick only the best one; involves a ranking process

portfolio

collection of assets

Modified IRR (MIRR):

combines the cash flows until only one change in sign remains.

examples of financial institutions

commercial banks, insurance companies, pension funds, and investment funds

NPV analysis is a ______________ analysis.

cost-benefit

Sunk costs

costs that have already been incurred

sunk costs

costs that have already been incurred; not relevant for current decisions but often have emotional impact

______________ is a measure of how two items may vary directly or indirectly.

covariance there is positive relationship (positive covariability) and inverse relationship

the discount rate when NPV(a) = NPV(b) is called _____________

crossover rate

steps of capital budgeting process

1. Develop long-term goals 2. Screen investments 3. Evaluate investments 4. Implement the project 5. Control 6. Audit

6 steps/phases of capital budgeting process:

1. Develop long-term goals 2. screen investments 3. evaluate investments 4. implement the project 5. control (modify or cut it) 6. audit

functions of money (ask one function of money)

1. Exchange = means of facilitating activity 2. Prices = allow for comparisons and purchases 3. Store of value

classes of information

1. Historic information = "weak form"; includes historic market information, such as price levels, trading volume, price movements, and is reflected in the price; involves technical analysis 2. Public information = "semi-strong form"; called fundamental analysis 3. Private information = "strong form"; monopoly of information where a few investors possess information not available to most investors in the market

rules for project cash flow estimates

1. Include cash flows, and only cash flows, in calculations (so not accounting revenues and expenses) 2. Include impact of the project on cash flows from other product lines 3. Include all opportunity costs 4. Forget sunk costs 5. Include only after-tax cash flows in the cash flow calculation (so use marginal tax rates)

Major capital budgeting decision rules:

1. NPV 2. IRR 3. PI (profitability index) 4. Payback period (focuses on liquidity) 5. Account rate of return (ARR) (project is accepted if it exceeds the minimum rate set by the managers) 4 and 5 are traditional method. Traditional because they don't use the elements of economic value.

What are the steps involved in issuing securities to the public in chronological order.

1. Obtain approval from the firm's board of directors 2. Prepare and file a registration statement 3. Prepare and distribute preliminary prospectus copies 4. Determine a selling price 5. Prepare and distribute a final prospectus

New York Stock Exchange

A formal exchange with a physical location.

A project should be ________________ if its NPV is greater than zero

Accepted

Broker

An entity that brings security buyers and sellers together but does not maintain an inventory.

non-financial asset

"real" asset, such as a piece of equipment or plant that generates cash flows

What is the price of a stock at the end of one year (P1) if the dividend for year 2 (D2) is $5, the price for year 2 (P2) is $20, and the discount rate is 10%.

$22.73

firm commitment

money promised regardless of demand

systematic factors

ones that systematically affect all companies in an economy; examples include commodity prices, such as electricity, interest rates, exchange rates

The production decision creates ____________ leverage.

operating includes CGS, SGA, Dep, NOI

A _____________ is a collection of assets.

portfolio

synergy

positive effect where the project would increase the cash flows from existing operations

exercise price

price at which asset can be purchases or sold through the contract

overreaction and correction

price over-adjusts to the new information; it overshoots the new price and subsequently corrects

delayed reaction

price partially adjusts to the new information; eight days elapse before price completely reflects the new information

A firm concentrated in a particular industry or operation is called __________

pure play firm

Historically, the real return on Treasury bills has been:

quite low

profitability index (PI)

ratio of the present value of the inflows and outflows used in NPV; calculates wealth created per dollar invested; project is acceptable if this is greater than one, but rejected if it's less than one

Income component

receiving cash payments from an asset.

comparative advantage

resources are not uniformly distributed

Indirect expenditures

result from our decision to purchase the asset, should also be included at the project's inception

low beta asset (B < 1)

return is less volatile than the market; associated with production of items that have a more stable demand

high beta asset (B > 1)

return is more volatile than the market; associated with more cyclical demand

diversification

risk reduction caused by holding imperfectly correlated assets

unsystematic risk

risk that affects a single asset or a small group of assets

bootstrapping

scraping up funds in any way; often involves using personal savings, selling personal assets, borrowing against assets, using credit cards, and taking on personal loans to raise capital; friends and relatives

fixed exchange rate system

system in which exchange rates do not change in value; currency values are fixed by an overt decision of the governments involved to support the value of their currencies

When an investor is diversified only ___________ risk matters.

systematic

gilts

British and Irish government securities

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

Cannot be observed

What is a disadvantage of the Profitability Index?

Cannot rank mutually exclusive projects

If you buy a stock for $10 and later sell it for $16, you will have a __________.

Capital Gain for $6

WACC is used to discount

Cash Flows

Which of the following are considered relevant cash flows? Cash Flows from Beneficial Spillover Effects Cash Flows from Sunk Costs Cash Flows from Erosion Effects Cash Flows from External Costs

Cash Flows from beneficial spillover effects Cash flows from erosion effects Cash flows from external costs

Modified IRR (MIRR):

Combines the cash flows until only one change in sign remains.

Which of the following are fixed costs? Cost of Equipment Rent on a Production Facility Inventory Costs Net Working Capital

Cost of Equipment Rent on a Production Facility

Which one of the following will increase the operating cash flow as computed using the tax shield approach?

Decrease in fixed costs

Accelerated Cost Recovery System (ACRS)

Depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

Out-of-the-money

Describes an option that if exercised immediately results in a loss of money.

Which of the following is true of dividend growth patterns? May grow at a constant rate Always reduce at a differential rate Never Grow Never has a zero growth rate

Dividends may grow at a constant rate

Dividend yield

Dividends per share of common stock divided by market price per share, which is the percentage income return on the stock.

In general, NPV is ________ Positive for discount rates above the IRR Equal to Zero when the discount rate equals the IRR Negative for Discount rates above the IRR Positive for Discount Rates below the IRR

Equal to zero when the discount rate equals the IRR Negative for Discount Rates above the IRR Positive for Discount Rates below the IRR

Capital Asset Pricing Model (CAPM)

Equation of the security market line showing the relationship between expected return and beta.

If the firm is all-equity, the discount rate is equal to the firm's cost of ________________ capital.

Equity

Side effects from investing in a project refer to cash flows from:

Erosion Effects Beneficial Spillover Effects

Flo is considering three mutually exclusive options for the additional space she plans to add to her specialty women's store. The cost of the expansion will be $148,000. She can use this additional space to add children's clothing, an exclusive gifts department, or a home décor section. She estimates the present value of the cash inflows from these projects are $121,000 for children's clothing, $178,000 for exclusive gifts, and $145,000 for decorator items. Which option(s), if any, should she accept?

Exclusive gifts only

We underestimate NPV because of the option(s) to _____________.

Expand (or Abandon)

True or False: An advantage of the AAR is that it is based on book values, not market values.

False

True/False: Political Risk refers only to problems for US companies caused by foreign governments

False

For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed. T/F

False Neither dividends nor capital gains are fixed or guaranteed

Pro forma financial statements

Financial statements projecting future years' operations.

Third-round stage/mezzanine financing

Financing for a company that is breaking even and expanding.

Start-up stage

Financing for firms started within the past year to pay for marketing and product development.

Venture capital (VC)

Financing for new, often high-risk ventures.

You want to use the pure play approach to assign a cost of capital to a proposed investment. Which one of the following characteristics should you most concentrate on as you search for an appropriate pure play firm?

Firm operations

Unsystematic Risk will affect

Firms in a single industry A specific firm

To estimate the dividend yield of a particular stock, we need:

Forecasts of the Dividend Growth Rate, g The Last Dividend paid, D0 The current stock price

A PE Ratio that is based on estimated future earnings is known as a __________ PE ratio.

Forward

Fourth-round financing/bridge financing

Funds for companies that are likely to go public within half a year.

The profitability index is calculated by dividing the PV of the ______________ cash inflows by the initial investment.

Future

The second lesson from studying capital market history states that the _________ the potential reward, the _____________ the risk

Greater;Greater Less;Less

The risk-return relationship states that a riskier investment should demand a ____________ return

Higher

The Financing Decision

How the project will be financed

_______________ are the periodic cash inflow and outflow that occur iff an investment project is accepted.

ICFAT

Internal Rate of Return (IRR)

IRR gives the rate of return earned on a project. To make a decision managers must compare the IRR to the opportunity cost.

What are the two main benefits of performing sensitivity analysis?

Identifies the variable that has the most effect on NPV It reduces a false sense of security by giving a range of values for NPV instead of a single value

Stock Price Reporting has increasingly moved from traditional print media to the ____________ in recent years.

Internet

Investment in net working capital arises when ___________.

Inventory is purchased Cash is kept for unexpected expenditures Credit Sales are Made

Supplemental Liquidity Providers (SLP)

Investment firms that agree to be active participants in stocks assigned to them and provide more liquidity to the market.

Supplemental Liquidity Providers (SLP).

Investment firms that agree to be active participants in stocks assigned to them and provide more liquidity to the market.

Angel investors

Investors who invest their own funds to provide seed capital for starting a business

Venture capitalist (VC)

Investors who provide initial capital to promising business venture capital.

In the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NPV calculation is to changes in underlying assumptions

What is true concerning triangle arbitrage?

It helps keep the currency market in equilibrium It is a profitable situation involving three separate currency exchange transactions

The payback period can lead to foolish decisions if it used too literally because:

It ignores cash flows after the cutoff date

What is an important drawback of traditional NPV analysis?

It ignores managerial options in investment decisions

What is the definition of expected return?

It is the return that an investor expects to earn on a risky asset in the future

What are the two main drawbacks of sensitivity analysis?

It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive It doesn't consider interaction among variables

If an international firm borrows money in the foreign country where it has operations it can reduce _________.

Long-run exchange rate exposure

Unanticipated changes in relative economic conditions that affect the value of a foreign operations ae known as:

Long-term exposures to exchange rate risk

If a project has multiple internal rates of return, which of the following methods should be used? IRR NPV MIRR

MIRR & NPV

Ranking Decision

Managers must rank the projects in order of desirability, pick the best projects, and stop when out of capital.

Systematic risk is also called ________ risk

Market

designated market makers

NYSE members who act as dealers in particular stocks; formerly known as "specialists"

Which of the following techniques will provide the most consistently correct result? Internal Rate of Return Payback Average Accounting Return Net Present Value

Net Present Value

A manager has estimated a positive NPV for a project. What could drive this result? Overly optimistic management The project is a good investment The cash flow estimations are inaccurate Management rationality

Overly optimistic management The project is a good investment The cash flow estimations are inaccurate

What is the formula for the present value of a growing perpetuity where C1, is the net cash flow, R is the required return and g is the growth rate? P=C1/(R-g)^2 P=C1/(R-g) R=P-C1/g P=C1-g/R

P=C1/(R-g)

The ___________ method evaluates a project by determining the time needed to recoup the initial investment.

Payback

Preferred stock has preference over common stock in the: Number of Votes given Payment of Dividends Distribution of Corporate Assets Portfolios of Individual Investors

Payment of Dividends Distribution of Corporate Assets

Preferred stock ____________

Pays a constant dividend Pays dividends in perpetuity

Triangular arbitrage

Performing three offsetting deals simultaneously to obtain an arbitrage profit. The cross rate of the UK pound and the euro (£/€) must be in equilibrium with these currency's exchange rates to the dollar, ($/£) and ($/€).

If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be:

Positive

The NPV is __________ if the required return is less than the IRR, and it is ____________ if the required return is greater than the IRR

Positive, Negative

Initial public offerings of stock occur in the _________ market.

Primary

Shares of stock are first brought to the market and sold to investors in the ____________ market.

Primary

What is an example of a sunk cost?

Project consultation fee

Crowdfunding

Raising capital from a large number of investors, often through the internet.

The preliminary prospectus, which contains much of the information found in the registration statement and is distributed to potential investors, is called a

Red Herring

If an all-equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be:

Rejected, when it should be accepted

One of the most important steps in estimating cash flow is to determine the ____________ cash flows

Relevant

West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately West Corporation lost money on the project. This may have been avoided had they assessed the ___________ of the cash flow estimates.

Reliability

opportunity cost aka ____________

Required Rate of Return

If the IRR is greater than the ___________ ___________, we should accept the project.

Required Return

Internal Rate of Return (IRR) must be compared to the ____________ in order to determine the acceptability of a project.

Required Return

Which of the following is a disadvantage of the payback period rule? Adjusts for uncertainty of later cash flows Requires an arbitrary cutoff point Easy to understand Biased toward liquidity

Requires an arbitrary cutoff point

If an asset has a reward-to-risk of 6.0%, that means it has a ___________ of 6.0% per unit of ___________.

Risk premium; Systematic Risk

The excess return is the difference between the rate of return on a risky asset and the _____________ rate

Risk-Free

To estimate a firm's equity cost of capital using the CAPM, we need to know the ________________

Risk-Free Rate, Stock's Beta, Market-Risk Premium

What is the difference between scenario analysis and sensitivity analysis?

Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time

The growth rate of dividends can be found using:

Security Analysts' Forecasts Historical Dividend Growth Rates

When using ________________, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.

Sensitivity Analysis

The different types of exchange rate risk include which of the following? Short-term exposure Translation Exposure Long-Term Exposure Arbitrage Exposure

Short-Term Exposure Translation Exposure Long-Term Exposure

Which of the following is true relative to capital rationing? Soft rationing cannot be overcome even if a superior project is found Soft rationing is typically internal in that the firm allocates funds to divisions for capital projects Hard rationing implies the firm is unable to raise funds for projects Hard rationing is typically a decision made by top management

Soft rationing is typically internal in that the firm allocates funds to divisions for capital projects Hard rationing implies the firm is unable to raise funds for projects

New York Stock Exchange Designated Market Makers (DMMs) were formerly called ___________

Specialists

An agreement to trade currencies within two business days at today's exchange rate is called a ____________.

Spot Trade

The basic approach to evaluating cash flow and NPV estimates involves asking:

What-If Questions

NPV Investment Rule

When making an investment decision, take the alternative with the highest NPV. Choosing this alternative is equivalent to receiving its NPV in cash today.

Second-round stage

Working capital funds for companies that are selling product but not yet profitable.

For a firm with outstanding debt, the cost of debt will be the ____________ on that debt.

Yield-to-Maturity

Which of the following is true about a firm's cost of debt?

Yields can be calculated from observable data It is easier to estimate than the cost of equity

If the growth rate (g) is zero, the capital gains yield is _______

Zero

The IRR is the discount rate that makes NPV equal to ________________.

Zero

divisible

a company can take a portion of a project

pure play firm

a firm concentrated in a particular industry or operation

Beta

a standardized correlation measure that measures the market risk relative to the variability of the economy

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

spot trade

agreement to trade currencies within 2 business days at today's exchange rate

call option

allows buyers to purchase, or call, the asset from the writer; "in the money" when spot price is greater than the exercise price and "out of the money" when exercise price is greater

Crowdfunding

allows individuals to use specialized Internet sites, describe their companies and projects, and ask individuals for funds

crowdfunding

allows individuals to use specialized Internet sites, describe their companies and projects, and ask individuals for funds; popular in creative areas; must hit minimum number of individuals

put option

allows the buyers to sell, or put, the asset to the writer

Free Cash Flow (FCF)

amount of cash generated by a company that is available to distribute to the firm's creditors and owner

balance of payments

an accounting statement issued by a government measuring the flows of goods, services, and capital between a country and its trading partners; records the actions of the country's central bank in managing its national currency

BOP

an accounting statement issued by a government that measures the flows of goods, services, and capital between a country and its trading partners

The goals of risk analysis in capital budgeting include: assessing the degree of financing risk identifying critical components zeroing in on the correct NPV determining the correct discount rate

assessing the degree of financing risk identifying critical components

fundamental business of NYSE

attract order flow

The weighted average cost of capital (WACC) represents the _______ risk

average

For ARR calculation, NI is not adjusted for time-value. It is simply __________

averaged

market consensus

balance of supply and demand, concerning the value of the security and the future prospects of the company

more operating and financial leverage mean a higher _____ and higher ____________

beta, risk

eurobond

bond issued in multiple countries but denominated in a single currency

the level of sales at which a project goes from loss to profit is called __________________ point

break-even

The percentage change in the price of a stock over a period of time is called its:

capital gain yield

_______occurs when a company has limited capital and cannot take on all wealth-increasing projects. With ________ the company must rank projects and choose the best projects given the capital constraint. This is different from mutually exclusive projects, in that multiple projects can be selected.

capital rationing

erosion

cash flows of a new project that come at the expense of a firm's existing projects; only relevant when the sales would not otherwise be lost

ranking decision with mutually exclusive projects

caused by the nature of the projects themselves.

net operation income

change in sales - change in costs - change in depreciation

The pro forma income statements for a proposed investment should include all of the following except:

changes in net working capital.

North American Industry Classification System

classifies businesses based on the collection, analysis, and publication of economic data related to the U.S., Canada, and Mexico

divisible

company can take on a portion of a project

reinvestment approach

compounds all of the cash flows, except for the initial cash flow, to the end of the project

The reinvestment approach to the modified internal rate of return:

compounds all of the cash flows, except for the initial cash flow, to the end of the project.

interest payments to bondholders

considered a business expense and are considered tax deductible

incremental cash flows

consist of all change in the firm's futue cash flows that are a direct consequence of taking the projects

_______________ measures the strength as well as direction of the relationship between two assets.

correlation coefficient

_________________ is the minimum acceptable rate of return a project must earn.

cost of capital

project's opportunity cost is often called ______________

cost of capital

Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:

cost of debt.

Venture Capital

develop businesses into viable, profitable companies through their investment of capital that more traditional investors may not make.

decreasing cash flows in other parts of the company is called _____________

erosion

Forecasting risk is best defined as:

estimation risk.

risk premium

excess return required from an investment in a risky asset over that required from a risk-free investment

core inflation

excludes food and energy; price bounce around but tend to move back toward the core

The weighted average cost of capital (WACC) is appropriate to use if a project matches the firm's _______________

existing risks

broker

facilitates trades by bringing buyers and sellers together but never buys the assets; receive commission

unique factors

factors that affect a firm as a firm individually; examples include manufacturing difficulties, key personnel turnover, and mistakes by leaders

with levered firm, NI is lower but we also have to note that income is distributed to _________ shareholders.

fewer

the type of money right now is called ___________ money

fiat

indirect financing

financial institutions that are intermediaries between investors and borrowers

best efforts basis

firm bears the risk of the issue not being fully sold

capital structure

firm's relative mix of debt and equity financing

probability distribution

formula or table of information giving the potential outcomes and the likelihood of those outcomes

internal rate of return (IRR)

gives rate of return earned on a project, which can then be compared to the opportunity cost to determine whether the project should be adopted; relative, percent measure that estimates what the project will earn on a per-period basis; discount rate that makes the NPV of an investment zero

operating leverage

greater the relative use of fixed, rather than variable costs, the greater the magnification of a change of sale into a larger change in operating income

The value of a firm is derived using the firm's _______ rate and its ______ rate

growth; discount

The second lesson from studying capital market history is that risk is...

handsomely rewarded

capital rationing

happens when there is not enough capital to take on all wealth-increasing projects

Capital gain.

he difference between the purchase price and sales price of an asset. The positive change in the value of an asset. A negative capital gain is a capital loss.

companies that are very cyclical will have a ______ beta

higher

Interest Expenses incurred on debt financing are __________ when computing cash flows from a project

ignored

head inflation

includes everything that people buy

components of return on investment

income component and capital gain or loss

For _____________ projects, you either take all or nothing

indivisible

NPV should be used to make decision for _______ projects.

indivisible

Decrease in the purchasing power of a currency is called ________

inflation

The capital gain yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the:

initial stock price

___________ is where executives or anyone connected with them uses private information about their company to trade against their own shareholders

insider trading

risk-free rate

intercept of the security-market line

cash flow from assets

interchangeable with Free Cash Flow

official reserve transactions

intervention in the foreign exchange markets

fixed cost is _________ related to sales and profit.

inversely

venture capital

investment of capital that more traditional investors may not make; develop businesses into viable companies

inflation premium

investors require this to balance loss of purchasing power from inflation

Long-term or capital expenses

involve obtaining the major asset

Indirect financing

involves financial institutions that are intermediaries between investors and borrowers.

Direct financing

involves markets where companies issue financial securities to expand and build their operations.

foreign bonds

issued in a single country and are usually denominated in that country's currency

Finding a firm's overall cost of equity is difficult because:

it cannot be observed directly

indivisible

managers must take all or nothing

investors should include _________ into their opportunity cost because you cannot reduce it.

market risk

systematic risk

market risk

cash inflow

If a project requires a lower working capital investment

Forward trade

Agreement to exchange currency at some time in the future.

Swaps

Agreement to exchange two securities or currencies.

The Profitability Index is also called the __________ ratio.

Cost-Benefit

Which of the following is tax-deductible to the firm?

Coupon interest paid on bonds

Differential/nonconstatt growth.

Dividends grow at a varying rate, but eventually settle into constant-growth.

The two most important stock markets in the U.S. are the New York Stock Exchange and _________ .

NASDAQ

Forward exchange rate

The agreed-upon exchange rate to be used in a forward trade.

Beta

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset.

Payback period

The amount of time a project takes to pay back its initial investment.

Straight-line depreciation:

The assets cost, less salvage value, is divided equally over its estimated useful life.

If unpaid preferred dividends must be "caught up" before any common dividends can be paid, they are called _______ dividends.

Cumulative

Straight voting.

A shareholder may cast all of his or her votes for each candidate for the board of directors, when the directors are elected one at a time.

Accredited investor

A sophisticated investor who is able to evaluate the risks of a complex investment. Measured by high personal wealth and/or income.

Covariance

A statistical measure of the degree to which random variables move together.

Cash flows should always be considered on a(n) _______________ basis.

After-tax

Cash flows used in project estimation should always reflect:

After-tax cash flows Cash flows when they occur

Which one of the following statements is correct? Assume the pretax cost of debt is less than the cost of equity

A firm may change its capital structure if the government changes its tax policies

Total payout model:

A firm's total payouts to equity holders (i.e., all the cash distributed as dividends and stock repurchases) are discounted and then divided by the current number of shares outstanding to determine the share price.

Stock exchange/market

A formal structure in which financial securities are traded

Stock exchange/market

A formal structure in which financial securities are traded.

Proxy.

A grant of authority by the shareholder to transfer his or her voting rights to someone else.

NPV Profile

A graph of the project's NPV over a range of discount rates.

NPV Profile:

A graph of the project's NPV over a range of discount rates.

Probability distribution

A graph or chart that provides the probability of every possible discrete state.

Net present value profile

A graphical representation of the relationship between an investment's net present value and various discount rates. It also shows the IRR for the project.

Net present value profile.

A graphical representation of the relationship between an investment's net present value and various discount rates. It also shows the IRR for the project.

Variance

A method to measure the risk of a probability distribution, it is the expected squared deviation from the mean.

Dividend-discount model:

A model that values shares of a firm according to the present value of the future dividends the firm will pay.

Cumulative voting.

A procedure whereby a shareholder may cast all of his or her votes for one member of the board of directors, when the directors are elected all at once.

Independent project

A project whose acceptance or rejection is independent of the acceptance or rejection of other projects.

Systematic risk

A risk that affects a large number of assets, each to a greater or lesser degree. Also called market risk, nondiversifiable risk, or common risk.

What is an ADR (American Depository Receipt)?

A security issued in the US that represents shares of a foreign stock

American Depositary Receipt (ADR)

A security issued in the United States representing shares of a foreign stock and allowing that stock to be traded in the United States.

The PI rule for an independent project is to _____________ the project if the PI is greater than 1

Accept

Payback investment rule

Accept a project if the project cash flows pay back the initial investment within a specified period of time.

The internal rate of return (IRR) investment rule

Accept any investment opportunity where the IRR exceeds the opportunity cost of capital. Reject any opportunity whose IRR is less than the opportunity cost of capita.

The internal rate of return (IRR) investment rule:

Accept any investment opportunity where the IRR exceeds the opportunity cost of capital. Reject any opportunity whose IRR is less than the opportunity cost of capita.

Profitability Index Decision Rule

Accept projects with a positive PI greater than 1 or some specified number.

Profitability Index Decision Rule:

Accept projects with a positive PI greater than 1 or some specified number.

What is true about the venture capital (VC) market?

Access to venture capital is very limited Personal contacts are important in gaining access to the VC market

First-round stage

Additional funds to begin sales and manufacturing.

The following are advantages of the SML approach

Adjusts for risk Does not require the company to pay a dividend

NASDAQ

An "over-the-counter" market that does not have a physical location. It is a system of market makers called dealers, who actually buy and sell securities and provide the service of making a market and who profit through the differences of their bid-ask prices. With this dealer system there are several prices in the market at the same time. (Think of a used car dealer, who will buy cars at one price (bid) and own them and park them on his/her used car lot. The dealer hopes to then sell the car at a higher (ask) price. The dealer makes a profit by buying low and selling high!)

NASDAQ.

An "over-the-counter" market that does not have a physical location. It is a system of market makers called dealers, who actually buy and sell securities and provide the service of making a market and who profit through the differences of their bid-ask prices. With this dealer system there are several prices in the market at the same time. (Think of a used car dealer, who will buy cars at one price (bid) and own them and park them on his/her used car lot. The dealer hopes to then sell the car at a higher (ask) price. The dealer makes a profit by buying low and selling high!)

Tombstone

An advertisement that announces a public offering of securities. It identifies the issuer, the type of security, the underwriters, and where additional information is available.

Spot trade

An agreement to trade currencies based on the exchange rate today for settlement within two business days.

Designated Market Makers (DMM)

An entity in the NYSE who is the exchange's market maker, responsible for making an "orderly market" in a given stock by matching buyers and sellers. With the DMM system, there is only one price in the market at a given time.

Broker.

An entity that brings security buyers and sellers together but does not maintain an inventory.

Dealer

An entity that maintains an inventory and stands ready to buy and sell at any time

Dealer

An entity that maintains an inventory and stands ready to buy and sell at any time.

Method of comparables

An estimate of the value of a firm based on the value of other, comparable firms or other investments that are expected to generate very similar cash flows in the future.

Unsystematic risk

Any risk that specifically affects a single asset, or a small group of assets. Also called unique risk, idiosyncratic risk, or diversifiable risk.

Negative correlation

Asset returns tend to move in opposite directions: when Asset A's return is above its expected value, Asset B's return is below its expected value

Positive correlation

Asset returns tend to move together: when Asset A's return is above its expected value, Asset B's return is also above its expected value.

Terminal Cash Flows

At the conclusion of a project, management will restore the company to its original condition without the project

The Average Accounting Return is defined as:

Average Net Income/Average Book Value

Expected return

Average of the possible returns weighed by their probabilities. Return on a risky asset expected in the future.

4. By how much is the statistical discrepancies in surplus or deficit?

BOPs are estimates: there is no way that a government could measure all of a country's trade and investment. There is also much informal and/or illegal activity that does not get factored into the BOP. You don't see an entry for drug smuggling. As the BOP must balance, given a Current Account deficit of $10, a Capital Account surplus of $21, and official reserves a deficit of $10, the Statistical Discrepancies must be a deficit of 1. Now, one finial issue: Would you normally see a country running a surplus in its current and its capital accounts? The answer is no. If a country is experiencing a current account deficit, it will generally experience a capital account surplus. This means that "excess" debits in the current account are balanced by "excess" credits in the capital account. This balance must occur (1) from a technical reason that credits must equal debits and, more importantly, (2) because the flow of wealth between the home country and its trading partners must balance. A current account deficit creates an excess supply of home currency to the foreign exchange market. If some way is not found to create more demand for the home currency the exchange rate will begin to decline in value. Eventually, foreigners will not want to hold the home currency because they have no need for it and forsee that it will continue to loose value. If, however, foreigners desire to purchase home-country assets they must obtain the home currency. Their action is purchasing domestic assets leads rise to increased demand for the home currency, which is reflected in a capital account surplus. So, a current account deficit is balanced by a capital account surplus. This situation also means that the home country is continuously selling claims against its future wealth. If the current account deficit is caused by overconsumption, noncompetitive products or foreign trade barriers, the home country is not building its productive capital, and will have problems in paying back these foreign claims.

Opportunity costs are ___________.

Benefits lost due to taking on a particular project

Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset? Book value represents the purchase price minus the accumulated depreciation Taxes are based on the difference between the purchase prices and sales price of the asset Taxes are based on the difference between the book value and the sales price There will be a tax savings if the book value exceeds the sales price.

Book value represents the purchase price minus the accumulated depreciation Taxes are based on the difference between the book value and the sales price There will be a tax savings if the book value exceeds the sales price

Which of the following are true? Book values are often similar to market values for debt Ideally, we should use market values in the WACC Book values are often similar to market values for equity Ideally, we should use book values in the WACC

Book values are often similar to market values for debt Ideally, we should use market values in the WACC

Gilts

British and Irish government securities.

A person who brings buyers and sellers together is called a(n) _____________

Broker

Capital __________ is the decision making process for accepting and rejecting projects.

Budgeting

Arbitrage

Buying an asset in one market at a lower price and simultaneously selling an identical asset in another market at a higher price. This is done with no risk and after all costs are properly accounted for.

The use of local financing from the government of the foreign country where the operation is located _________.

Can reduce political risk

Free cash flow

Cash flow that is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments.

Which of the following are weaknesses of the payback method? Cash flows are received after the payback period are ignored All cash flows are included in the payback period The cutoff date is arbitrary Time value of Money principles are ignored

Cash flows received after the payback period are ignored The cutoff date is arbitrary Time value of money principles are ignored

Portfolio

Combined holding of more than one stock, bond, real estate asset, or other asset by an investor.

advantages of trade that result in a higher standard of living

Comparative Advantage Increased Competition Economies of Scale Increase in Variety of Products

The Combination MIRR method is used by the Excel MIRR function and uses which of the following? Compounding Cash INFLOWS to the end of the project A single discount rate for both discounting and compounding A financing rate for discounting A reinvestment rate for compounding Compounding ALL cash flows to the end of the project Discounting ALL cash inflows to time 0 Discounting all cash OUTFLOWS to time 0

Compounding cash INFLOWS to the end of the project A financing rate for discounting A reinvestment rate for compounding Discounting all cash OUTFLOWS to time 0

NASDAQ has which of these features? Computer network of securities dealers Single DMM System Multiple Market Maker System Physical Trading Floor

Computer Network of Securities Dealers Multiple Market Maker System

Three special case patterns of dividend growth discussed in the text include: Constant Zero Discounted Negative Non-Constant Fast

Constant, Zero, and Non-Constant

Primary market.

Corporations, with the assistance of investment banks, create financial securities and issue them to the investing public. This is how companies raise capital.

The appropriate discount rate to use to evaluate a new project is the _________________.

Cost of Capital

The minimum required return on a new project is known as the:

Cost of Capital

Which of the following are components used in the construction of the WACC?

Cost of common stock Cost of Debt Cost of preferred Stock

All else constant, the dividend yield will increase if the stock price ________

Decreases Ex: suppose a company pays a $2.50 dividend and the stock price is $50 - the dividend yield is $2.50/$50 = 5%. Suppose the stock price increases to $60- then the dividend yield decreases to $2.50/$60 = 4.17%. Alternatively, if the stock price drops to $40, the dividend yield increases to $2.50/$40 = 6.25%

The Tax Shield Approach

Determine the project's cash flow without depreciation expense, then add the depreciation tax shield.

Incremental Cash Flows comes about as an ________________ consequence of taking a project under consideration

Direct

Registration statement

Discloses all the pertinent information concerning a corporation that wants to make a public offering. The statement is filed with the Securities and Exchange Commission.

If the Japanese Yen is less expensive in the forward market than it is today, it is said to be selling at a(n) _________________.

Discount

The rate used to discount project cash flows is known as the ___________

Discount Rate; Required Return; Cost of Capital

The net present value profile illustrates how the net present value of an investment is affected by which one of the following?

Discount rate

Zero-growth.

Dividend are assumed to be constant in amount, with no growth and take the form of a level perpetuity.

Which of the following represents the valuation of stock using a zero-growth model? (Dividend)^discount rate = D^R Dividend X Discount Rate = D x R Dividend/Discount Rate = D/R Discount Rate / Dividend = R/D

Dividend/Discount Rate = D/R

The dividend growth model is applicable to companies that pay ______________.

Dividends

Which of the following are cash flows to investors in stocks? Fees Interest Dividends Capital Gains

Dividends Capital Gains

Constant-growth.

Dividends are assumed to grow at a constant rate and take the form of a growing perpetuity.

The constant-growth model assumes that _______

Dividends change at a constant rate

Which of the following are important considerations when choosing between venture capitalists? Exit Strategy SEC Affiliation Financial Strength Style Tombstones

Exit Strategy Financial Strength Style

The price of a share of common stock is equal to the present value of all ________ future dividends.

Expected

cash outflow

If a project requires a working capital investment

Market portfolio

In concept, a value-weighted index of all securities. In practice, it is an index, such as the S&P 500.

An increase in depreciation expense will _____________ cash flow from operations.

Increase

Synergy will _____ the sales of existing products

Increase

Which one of these represents systematic risk?

Increase in consumption created by a reduction in personal tax rates

The stand-alone principle assumes that evaluation of a project may be based on the project's _________________ cash flows

Incremental

The difference between a firm's cash flows with a project versus without the project is called _______________.

Incremental Cash Flows

A(n) ___________ project does not rely on the acceptance or rejection of another project.

Independent

Expected information

Information that was already known or was forecasted by market participants. This is used to set the expected return.

Unexpected information

Information that was not known or forecast by market participants. This information will change the actual return received.

The present value of the future cash inflows are divided by the ____________ to calculate the profitability index

Initial Investment

According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?

Internal Rate of Return Net Present Value

__________ is the per-period rate of return developed from a project's time line. They should only accept the project if it earns (IRR) more that should be expected (RRR) given other projects of equivalent risk.

Internal Rate of Return IRR

Foreign bonds

International bonds issued in a single country, usually denominated in that country's currency.

Eurobonds

International bonds issued in multiple countries but denominated in a single currency (usually the issuer's currency).

Components of the WACC include funds that come from ____________

Investors

Which of the following are reasons why NPV is considered a superior capital budgeting technique? It considers time value of money It considers the riskiness of the project It properly discounts earnings It considers all the cash flows It properly chooses among mutually exclusive projects

It considers time value of money It considers the riskiness of the project It considers all the cash flows It properly chooses among mutually exclusive projects

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons

It determines the book value of assets which affects net salvage value It determines taxes owed on fixed assets when they are sold It affects a firms annual tax liability

What is a risk premium?

It is additional compensation for taking risk, over and above the risk-free rate

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

It is likely to decrease It may eventually be almost totally eliminated

What is an uncertain or risky return?

It is the portion of return that depends on information that is currently unknown.

A positive NPV exists when the market-value of a project exceeds its cost. Which of these two values is the most difficult to establish?

Market Value

The most appropriate weights to use in the WACC are the ______________ weights

Market Value

Efficient capital market

Market in which security prices reflect available information.

What is a Eurocurrency?

Money deposited in a financial center outside of the country with the involved currency.

Eurocurrency

Money deposited in a financial center outside the country whose currency is involved.

Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of five years.

Money spent last month repairing a damaged front fender

Corporations with significant foreign operations are often called __________.

Multinationals

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered _________________.

Mutually Exclusive

Which of the following present problems when using the IRR method? Mutually exclusive projects A High discount rate Non-conventional cash flows Larger cash flows later in the project

Mutually Exclusive Non-Conventional Cash Flows

With _____ you are choosing from among alternatives and can pick only the best one. In shopping for the refrigerator, you may visit several stores and look at a dozen refrigerators, but you will end up purchasing only one refrigerator--the one you think is best! Capital budgeting for ______ involves a ranking process.

Mutually Exclusive Projects

3. What is the balance in the official reserves account?

Official reserve accounts measures the changes in a currency's supply and demand caused by the country's central bank. The central bank may intervene to balance a difference in supply and demand created in the current and capital accounts, or to prop up a declining currency, or to push down a currency value to increase exports. In this case the US Central Bank sells (supplies) dollars to the foreign exchange markets, producing a deficit of $10.

When is a new issue usually priced?

On the last day of the registration period

Secondary market.

Once issued, these securities are traded among investors. The company is not involved with secondary market transactions. Note, primary and secondary markets are functions within the stock market, not separate markets

Profitability Index (PI)

PI is a ratio. It takes the same inputs--present values of inflows and present value of outflows--used for NPV but compares the relative wealth creation per dollar invested.

Dividend

Payment made by a firm to its owners, either in cash or in stock. Also called the income component of the return on an investment in stock.

Dividend.

Payment made by a firm to its owners, either in cash or stock. Also called the income component of the return on an investment in stock.

The security market line (SML) shows that the relationship between a security's expected return and its beta is _____________.

Positive

Which one of the following indicates that a project is expected to create value for its owners?

Positive net present value

Mutually exclusive projects

Projects in which the acceptance of one excludes accepting others. (can only pick one)

Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach?

Pure play approach

What is the required return on a stock (Re), according to the constant dividend growth model, if the growth rate (g) is zero?

Re=D1/P0

The formula for calculating the cost of equity capital that is based on the dividend discount model is:

Re=D1/P0+g

An option on a real asset rather than a financial asset is known as:

Real Option or Managerial Option

Which of the following is commonly used to measure inflation?

The Consumer Price Index (CPI)

The dividend yield is determined by dividing the expected dividend (D1) by ________

The Current Price (P0)

Floor Broker

The DMM works with brokers, who go to the exchange on behalf of their customers who wish to buy or sell financial securities. The broker does not own the security but acts as an agent and received a commission for the service. (Similar to a real estate broker. The broker doesn't own houses, but rather acts as the agent for someone wishing to sell a house. The broker gets a commission if the sale goes through. Same process for someone wanting to buy or sell stock.)

What are methods of calculating the MIRR of a project?

The Discounting Approach The Combination Approach The Reinvestment Approach

Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways? The Excel NPV function is actually a PV function. The range of cash flows specified in Excel begins with cashflow #1, not cashflow 0. The discount rate is Excel is entered as a decimal, or as a percentage with a percent sign With the Excel NPV function, Cashflow #0 must be handled outside the NPV function There are no significant differences between variable entry in Excel and in a financial calculator.

The Excel NPV function is actually a PV function The range of cash flows specified in Excel begind with cashflow #1, not cashflow 0 The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow #0 must be handled outside the NPV function

Which of the following are reasons why IRR continues to be used in practice? The IRR of a proposal can be calculated without knowing the appropriate discount rate It is easier to communicate information about a proposal with an IRR The IRR allows the correct ranking of projects Businesspeople prefer to talk about rates of return

The IRR of a proposal can be calculated without knowing the appropriate discount rate It is easier to communicate information about a proposal with an IRR Businesspeople prefer to talk about rates of return

Incremental IRR

The IRR of the incremental cash flows that would result from replacing one project with another.

Incremental IRR:

The IRR of the incremental cash flows that would result from replacing one project with another.

Which of the following ratios might be used to estimate the value of a stock? The Book to Value ratio The Price/Earnings ratio The Price/Sales ratio

The Price/Earnings ratio or The Price/Sales Ratio

Which act sets forth the federal regulation for all new interstate securities issues?

The Securities Act of 1933

What approach does the following formula describe? OCF=(Sales-Costs)x(1-T)+DepreciationxT

The Tax Shield Approach

Seed capital

The initial capital used when starting a business, often coming from the founders' personal assets, friends or family, for covering initial operating expenses and attracting venture capitalists. (Investopedia.com)

Prospectus

The legal document that must be given to every investor who contemplates purchasing registered securities in an offering. It describes the details of the company and the particular offering.

Foreign exchange market

The market in which one country's currency is traded for another's.

What is the slope of the security market line (SML)?

The market-risk premium

Cost of capital

The minimum rate of return required to undertake a project. Also called the required return, appropriate discount rate. The cost of capital is set by the risk of the investment!

Cost of Capital

The minimum required return on a new investment.

Modified Accelerated Cost Recovery System (MACRS)

The most accelerated cost recovery system allowed by the IRS. Based on the recovery period, ACRS depreciation tables assign a fraction of the purchase price that the firm can depreciate each year.

Expected returns

The normal, or expected return is the part of the return that shareholders in the market predict and expect to receive.

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

The operating cash flows from net sales over the life of the project

Which of the following qualify as "managerial options"? The option to change the cost of capital The option to Wait The option to Expand The option to Abandon

The option to Wait The option to Expand The option to Abandon

Frequency distribution

The organization of data to show how often certain values or ranges of values occur - the distribution of observed historic returns

Which of the following are examples of information that may impact the risky return of a stock?

The outcome of an application currently pending with the Food and Drug Administration The Fed's decision on interest rates at their meeting next week

Unexpected returns

The part of the return on the stock that comes from unexpected information revealed within the year.

What are the advantages of the payback period method for management? The payback period method is ideal for minor projects It allows lower level managers to make small decisions effectively The payback period adjusts for the discount rate The payback period method is easy to use

The payback period method is ideal for minor projects It allows lower level managers to make small decisions effectively The payback period method is easy to use

Capital gain

The positive change in the value of an asset. A negative capital gain is a capital loss.

Forecasting risk

The possibility that errors in projected cash flows will lead to incorrect decisions.

Discounted cash flow (DCF) valuation:

The present values used in NPV analysis are the present values of the incremental cash flows of the project.

Discounted cash flow (DCF) valuation

The present values used in NPV analysis are the present values of the incremental cash flows of the project. - Calculating the present value of a future cash flow to determine its value today; The process of valuing an investment by discounting its future cash flows.

Exchange rate

The price of one country's currency expressed in terms of another country's currency.

Price-Earnings ratio

The price that investors pay for $1 in earnings. Gives a measure of how expensive the stock is.

Payout ratio

The proportion of earnings paid out in dividends: 1 - the retention ratio.

Retention ratio.

The proportion of earnings retained and reinvested in the company.

Capital gain yield:

The rate at which the investment grows.

London Interbank Offered Rate (LIBOR)

The rate most international banks charge one another for overnight Eurodollar loans.

Internal rate of return (IRR)

The rate that causes the NPV of the project to be zero. The per-period rate earned on the project.

Profitability index

The ratio of the present value of the future expected cash flows after initial investment divided by the amount of the initial investment.

mutually exclusive projects that have different lives

To choose from among mutually exclusive ways to accomplish the same goal, the projects' economic lives should be equivalent.

Hedging

To reduce risk by holding contracts or securities whose payoffs are negatively correlated with some risk exposure.

If a firm uses its overall cost of capital to discount cash flows from projects in higher risk divisions, it will accept _____________ projects.

Too Many

When a US company calculates its accounting net income, it must report all income, including income from foreign operations, in dollars. This leads to _________ exposure to exchange rate risk.

Translation

Long-run exposure

Unanticipated changes in relative economic conditions may cause the value of foreign operations to change.

In a competitive market, positive NPV projects are:

Uncommon

_____ risk is reduced as more securities are added to the portfolio

Unsystematic; Company-Specific; Diversifiable

A US corporation can reduce political risk in a foreign country by which of the following ways?

Use local financing

Pure play approach

Use of a weighted average cost of capital that is unique to a particular project, based on companies in similar lines of business.

The cost of capital depends primarily on the ____________ of funds, not the ___________.

Use; Source

The WACC is the overall rate of return the firm must earn on its existing assets to maintain the ________________ of its stock.

Value

Inflation

Variability in the purchasing power of money more common in modern societies and we see prices increase over time Types: 1. Prices 2. Assets

The square of the standard deviation is equal to the _________.

Variance

Entrepreneurs seeking start-up capital must usually rely on ________________.

Venture Capital

Financing by wealthy individuals or private investment groups is referred to as _______________.

Venture Capital Private Equity

A firm's capital structure consists of 40% debt and 60% equity. The aftertax yield on debt is 2.5 percent and the cost of equity is 15%. The project is about as risky as the overall firm. What discount rate should be used to estimate the project's net present value?

WACC= .4 x 2.5% + .6 x 15% = 10%