FINA 4315 Exam Review

How can total risk be defined in terms of systematic and unsystematic risk? - Total risk = Systematic risk - Unsystematic risk - Total risk = Unsystematic risk - Systematic risk - Total risk = Systematic risk + Unsystematic risk - Total risk = Systematic risk &* Unsystematic risk

- Total risk = Systematic risk + Unsystematic risk

True of False. Failure to appreciate embedded real options lead to inaccurate decision making. - True - False

- True

Which of the following are possible consequences of choosing an improper financing instrument? - Undue risk - Reduced slaes revenue - Inability to sell the instruments - Excessive costs

- Undue risk - Inability to sell the instruments - Excessive costs

Financial leverage involves the use of ________ instead of _________ - Equity; fixed-cost debt - Fixed-cost production methods; variable-cost production method - Variable-cost production methods; fixed-cost production methods -Fixed-cost debt; equity

-Fixed-cost debt; equity

A firm has EBIT of $150 million and a times interest earned ratio of 6.0. How much can EBIT fall (in percentage terms) before the coverage drops to 1.0? - 80.7 - 66.7 - 75.0 - 83.3

83.3%

A firms________ value is the cash generated by selling the assets individually, while the __________ value is the present value the firm's expected cash flows. - merger; liquidation - liquidation; going-concern - merger; going-concern -going-concern; liquidation

- liquidation; going-concern

The market value of debt and equity for the Calhoun Tubbs Guitar Company are $25 million an $75 million, respectively. If the firm has an equity beta equal to 1.2, what is its asset beta? - 0.30 - 0.33 - 0.90 - 1.60

- 0.90

Andrew, Inc. has $40 Million in debt and $200 million in equity. The opportunity cost go the firm's debt is 8% and the opportunity cost go the firms equity is 12%. Assuming the firm faces a 40% marginal tax rate, find the cost of capital for Andrew, Inc. - 10.0% - 0.8% - 10.8% - 11.3%

- 10.8%

Jon, Inc. has a beta of 1.3 and government bonds are currently yielding 4.2%. If stocks have historically earned 6.2% more than bonds, what is the cost of capital for Jon, Ince. stock? - 11.66% - 5.46% - 8.06% - 12.26%

- 12.26%

A firm has an after tax- interest rate of 5% and a debt-to-equity ratio of 1.0. If the firm has a return on invested capital of 10%, What is the return on equity for the firm? - 20% - 5% - 10% - 15%

- 15%

Which of the following statements are correct? - A firms financing choice today may impact their ability to raise money in the future - A company's financing strategy should be compatible with how the firms intends to manage growth - A company's financing strategy should focus on entirely on the present needs of the company, ignoring future considerations - Some companies, especially smaller firms, may be unable or unwilling to sell stock

- A firms financing choice today may impact their ability to raise money in the future - A company's financing strategy should be compatible with how the firms intends to manage growth - Some companies, especially smaller firms, may be unable or unwilling to sell stock

Why is the range of possible ROEs a reasonable measure of risk? - A larger range of possible outcomes means there is a greater chance of bankruptcy - A larger range of possible outcomes means there is more certainty regarding how well the firm will perform - A larger range of possible outcomes means greater uncertainty about the company's ROE - A larger range of possible outcomes means the firm has lower leverage

- A larger range of possible outcomes means there is a greater chance of bankruptcy - A larger range of possible outcomes means greater uncertainty about the company's ROE

When debt level are low, the primary consequence of adding additional debt is ________. When debt levels are high, the primary consequences of additional debt is _________. - An increase in distress costs; a tax shield - An increase in distress costs; an increase in distress costs - A tax shield; a tex shield - A tax shield; an increase in distress costs

- A tax shield; an increase in distress costs

The option to terminate a project whenever termination value is greater than the present value of continuing a project is know as the option to ________.

- Abandon

Which firm is a good candidate for high levels of debt? - Low-growth, highly profitable firms - Startup firm with few physical assists - High-growth, high-technology firms

- Low-growth, highly profitable firms

To determine if a firm can safely carry additional debt, the firm should compare the company's forecasted operating cash flows to the annual financial burden imposed by the debt. Which of the following are appropriate ways to do this? - Determine if the revenues of the firm will be reduced by the new debt - Compare the firm's coverage ratios to the average coverage ratio for a firm in the S&P 500. - Calculate several coverage ratios - Construct pro forma financial forecasts, augmented with sensitivity analysis and simulations

- Calculate several coverage ratios - Construct pro forma financial forecasts, augmented with sensitivity analysis and simulations

Which of the following are methods a firm can use if it's evaluating a project with a different risk level than the overall firm? - Reject all high-risk projects to avoid accepting a project that should be rejected. - Compute a separate cost of capital for each division of the firm - Assign multiple risk categories and assign a discount rate to each category - Estimate the cost of capital for a firm in the same line of business as the proposed project

- Compute a separate cost of capital for each division of the firm - Assign multiple risk categories and assign a discount rate to each category - Estimate the cost of capital for a firm in the same line of business as the proposed project

Which of the following are steps in the process of selecting a proper financial instrument? - Decide how much capital is needed - Select and design the instruments to be sold - Determine the appropriate dividend rate or interest rate

- Decide how much capital is needed - Select and design the instruments to be sold

Why do venture capture capitalist require such high returns? - Entrepreneurs' forecast or future cash flows are typically too optimistic - Venture capitalist offer other services in addition to their investment - Very few venture capitalist investments are profitable - High returns allows all venture capitalists to earn higher-risk-adjusted returns than they could earn in the stock market

- Entrepreneurs' forecast or future cash flows are typically too optimistic - Venture capitalist offer other services in addition to their investment - Very few venture capitalist investments are profitable

True or false. When investors can borrow on their own and ignoring taxes, firm value will increase with the amount of debt. True false

- False

Which of the following is NOT a management function that is integrated through Economic Value Added (EVA)? - Financial statement construction - Performance appraisal - Investment evaluation - Incentive compensation

- Financial statement construction

Which of the following are pitfalls that an investment analysts should avoid in discounted cash flows analysis of a capital investment? - Forgetting that a constant discount rate implies that the cash flows grows with time - Using a nominal discount rate to value real cash flows and vice versa - ignoring the value of real options embedded in the project - Ignoring the expenses incurred to research the feasibility of the projects and to construct the cash flow estimates - Confusing an enterprise perspective with an equity perspective

- Forgetting that a constant discount rate implies that the cash flows grows with time - Using a nominal discount rate to value real cash flows and vice versa - ignoring the value of real options embedded in the project - Confusing an enterprise perspective with an equity perspective

A firms ________ is equal to EBIT (1-Tax rate) + Depreciation - Capital expenditures - working capital investments. - Operating Income - Free cash flow - Net income - Operating cash flow

- Free cash flow

Which of the following is not a reason that a firm with low growth prospects would want to maximize reliance on debt and use the proceeds to repurchase equity? - High debt levels create a tax shield - Increasing the use of debt increases managerial incentives - Repurchasing equity sends a positive signal to the market - High levels of debt will increase the firm's financial flexibility

- High levels of debt will increase the firm's financial flexibility

Which of the following describes how the financing decision can impact managerial incentives? - higher equity levels create more access to employees stock options - Higher equity levels lead to increased focus on creating shareholder value - Higher debt levels reduce managers incentives to waste money on frivolous or self-indulging projects - Higher debt levels reduce managers incentives to work harder

- Higher debt levels reduce managers incentives to waste money on frivolous or self-indulging projects

Which of the following are cost associated with financial distress? - Dilution of shareholders - Indirect bankruptcy costs - Conflicts of interest - Direct bankruptcy costs

- Indirect bankruptcy costs - Conflicts of interest - Direct bankruptcy costs

One way the financing decision affects the value of the firm is through the tax affect. The tax effect occurs because________. - dividends on equity are effectively taxed twice; once at the corporate level and once at the investor level - Interest expense on debt reduces the amount of taxes paid to the government - Dividends reduce the amount of taxes that must be paid to the government - The firm's taxes increase the riskiness of the firm

- Interest expense on debt reduces the amount of taxes paid to the government

Which of the following are methods used to estimate a company's terminal value? - Blue book value - Liquidation value - Book value - Private party value

- Liquidation value - Book value

Which of the following is not a reason that a rapidly growing firm would want low levels of debt? - The primary assets for high-growth firm is intangible growth opportunities - High-growth firms will have volatile cash flows - Low levels of debt will allow them to have a large dividend payout ratio - A firm with high growth prospects will need to revise the financial markets for financing multiple times

- Low levels of debt will allow them to have a large dividend payout ratio

The option to decide to undertake a project now or later is known as the _______ option.

- Timing

Why are poorly performing mangers often able to keep their Job? - Management often chooses the candidates who are going to run for a seat on the board of directors - Many members of a firm's board of directors are I siders of the firm and closely aligned with management - Hostile acquired are almost never able to win control of a firm and replace the firms management - the board of directors often believes its responsibility is to help management run the business

- Management often chooses the candidates who are going to run for a seat on the board of directors - Many members of a firm's board of directors are I siders of the firm and closely aligned with management - the board of directors often believes its responsibility is to help management run the business

High debt levels can lead managers, creditors, and owners to concentrate on their own interests rather than the interest of the firm. This leads to conflicts of interest among the different parties. What are the possible results from these conflicts of interest when debt levels are high? - Management uses excess capital to pay down debt at the expense of shareholders. - Management underinvests in low-risk projects because the benefits accrue to creditors instead of shareholders - Management will increase the dividend paid to shareholders. - Management over invests in risky projects because downside is limited to shareholders.

- Management underinvests in low-risk projects because the benefits accrue to creditors instead of shareholders - Management over invests in risky projects because downside is limited to shareholders.

When estimating the weights of debt and equity, it's appropriate to use (market/book)__________ values of debt and equity.

- Market

In theory, managers of a firm will want to issue equity when it thinks equity prices are too high and repurchase shares when it thinks prices are too low. This practice is an example of ________? - Market signaling - Information asymmetry - A conflict of interest - An illegal practice

- Market signaling

Financial economists typically refer to an asset's dispersion of returns as the _________ of the asset. - Risk - Expected return - Correlation

- Risk

Which of the following is not one of the basic questions that must be answered during the first steps of valuing a business? - Should we value the firm's assets or the firm's equity? - Are we to value a minority interest in the business or a controlling interest? - Shall we value the business as a going concern or in liquidation? - Should we compare nominal cash flows to a nominal discount rate, or real cash flows to a real discount rate?

- Should we compare nominal cash flows to a nominal discount rate, or real cash flows to a real discount rate?

The most common way to quantify the risk of an asset is to calculate the ________ of the asset's returns. - Mode - Average - Standard deviation - Median

- Standard deviation

Which of the following is not an enhancement created in an acquisition? - Improved management incentives - Tax shields from dividend payments - Tax shields from debt issuance - control over free cash flow

- Tax shields from dividend payments

If a financial analyst fails to account for inflation when estimating an investments inflows, but accounts for inflation in the discount rate, what will happen? - Nothing because the analyst is comparing nominal cash flows to a nominal discount rate - The analyst will accept projects that should be rejected - The analyst will reject projects that should be accepted - Nothing, because the analyst is comparing real, constant-dollar, cash flows to a real discount rate.

- The analyst will reject projects that should be accepted

Which of the following factors does not influence the cost of equity capital? - The risk-free interest rate - The assets unsystematic risk - The inflation rate - The asset's risk premium

- The assets unsystematic risk

Modigliani and Miller's capital irrelevance proposition states that, when cash flows are constant, _________ is irrelevant to the value of the firm. - The risk of the firm - The financial decision - The investment decision - The business environment

- The financial decision

Which of the following is not an example of a real option embedded in capital investments? - The option to abandon an investment if cash flows are too low - The option to write off the losses associated with an unprofitable investment - The option to defer investments to a later date - The option to make follow-on investments if the initial investment. is successful

- The option to write off the losses associated with an unprofitable investment

Identify the expected (probability) cost of bankruptcy . - The probability of bankruptcy will occur times the cost incurred when it does - The product of probability bankruptcy will occur and the shares capital of a company - The cost incurred when bankruptcy occurs divided by the probability of bankruptcy - The cost incurred when it bankruptcy occurs

- The probability of bankruptcy will occur times the cost incurred when it does

A firms cost of capital is an appropriate discount rate to use on a new project as long as the new project has _________ of risk as the existing firm. - A lower level - A higher level - The same level

- The same level

Which of the following is not a difference between valuing a business and valuing any other capital expenditure? - The value of an asset equals the present value of free cash flows discounted at the appropriated risk adjusted rate - Most capital expenditures have a finite life, but the life expectancy of a company is indefinite - Most capital investments involve cash flows that are stable or declining, while most businesses have cash flows that are growing - The cash flows of a capital expenditure belong to the owner, while the cash flows too a company go to the owner only if distributed

- The value of an asset equals the present value of free cash flows discounted at the appropriated risk adjusted rate

In a merger, one possible enhancement is tax shields. How are these tax shields generated. - By refusing the salary of the poorly performing managers of the target firm - Through the amortization of the premium paid for the merger - By improving the operating efficiently of the target firm - Through the issuance of debt, which carries an interest tax shields

- Through the issuance of debt, which carries an interest tax shields

Why is standard discounted cash flow valuation inappropriate to use for venture capital investments? - Venture capital investments typically cover near-term periods, with negative free cash flow - Venture capitalists invest in firms that are not publicly traded - Venture capital investments cover multiple capital injections at different rates of return - Venture capital investments are far more risky than standard capital budget investments

- Venture capital investments typically cover near-term periods, with negative free cash flow - Venture capital investments cover multiple capital injections at different rates of return

When calculating your firms cost of capital, how do you estimate the cost of debt? - Yield on bonds with similar risk and maturity - Maturity on bonds with similar risk - Coupon rate on bonds with similar risk and maturity

- Yield on bonds with similar risk and maturity

If a new project has more risk than existing firm, the firm should _______ the cost of capital when finding an appropriate discount rate. If the project has less risk, the firm should ________ the cost of capital to find an appropriate discount rate. - discount; add a premium to - discount; discount - add a premium to; discount - add a premium to; add a premium to

- add a premium to; discount

A firms has a price-to-earnings ratio of 15.4. The means that investors: - are willing to pay $1.00 top obtain $15.40 of a firms earnings - are willing to pay $15.40 to obtain one dollar of a firms earnings - are wiling to pay $1.00 to obtain $15.40 off a firms sales - are willing to $15.4o0 to obtain one dollar of a firms sales

- are willing to pay $15.40 to obtain one dollar of a firms earnings

when liquidation is likely _____ ratios are the most relevant. if investors are wary of the accuracy of a firms earnings, then ________ ratios are the most relevant - asset-based; sales-based - asset-based; earnings-based -earnings based; asset based - earnings-based; sales-based

- asset-based; sales-based

Assets beta measure ________ while the equity beta measures_______. - business risk; financial risk - financial risk; business risk - business and financial risk; business risk - business risk; business and financial risk

- business risk; business and financial risk

Using a constant discount rate to value an investment implicitly assumed that____________. This can be problematic since the risk of cash flows associated with the project typically becomes __________. - cash flows in the distant future are just as risky as those in the near future; more risky as the project becomes more successful. - cash flows in the distant future are more risky than those in the near future; more risky as the project becomes more successful. - cash flows in the distant future are more risky than those in the near future; less risky as the project becomes more successful. - cash flows in the distant future are just as risky as those in the near future; less risky as the project becomes more successful.

- cash flows in the distant future are more risky than those in the near future; less risky as the project becomes more successful.

The cost of capital is the return a firm must earn on its existing asset's to keep its stock price ________. - the same as its competitors - constant - growing

- constant

The concept of 'managerial incentives' suggests that firms should increase their reliance on _________ financing because such financing will force managers to maximize cash flow in order to avoid the increased risk of ___________. - debt; termination - debt; bankruptcy - equity; bankruptcy - equity; termination

- debt; bankruptcy

An analyst estimating a firms price per share should _________ the price if there is a lack of marketability and ________ the price if the owner of he stock will be able too exercise control. - discount; increase - increase; discount - increase; increase - Discount; discount

- discount; increase

When exalting a corporate investment partially financed with debt, the _________ perspective refers to the perspective of the company while the ________________ perspective refers to the perspective of the owners. - corporate; enterprise - equity; corporate - equity; enterprise - enterprise; equity

- enterprise; equity

When selecting the maturity structures of debt securities, the minimum level of risk is achieved when the maturity of liabilities _________ the maturity of assets. - equals - is less than - is greater than - is related to

- equals

The ________ value of an asset is the value a well-informed buyer would be willing to pay w well-informed seller when neither party is complied to buy or sell - fair market - liquidation - book - going-concern

- fair market

The risk of an individual asset is _______ its risk when it's part of a diversified portfolio, assuming the portfolio's returns are not perfectly positively correlated to the individual asset. - greater than - equal to - less than

- greater than

Bankruptcy cost are __________ when the firms assets are predominantly _______________ - higher; intangible assets - lower; intangible assets -higher; tangible assets - lower; tangible assets

- higher; intangible assets - lower; tangible assets

As a firms leverage increase, its equity beta will ________. - decrease - remain the same - increase

- increase

One enhancement form a merger can be improves managerial incentives from an increase in debt. How can a large debt-load improve managerial incentives? - debt holders are more likely to serve as police rather than partners, which will force management to maximize profits - it increases the risk of bankruptcy, which encourages managers to maximize free cash flow - Substituting debt for equity reduced the number of shareholders outstanding, which relives managers of pleasing many shareholders - Interest reduced net income, which means management will have to increase sale to continue to receive performance bonuses

- it increases the risk of bankruptcy, which encourages managers to maximize free cash flow

Based on his extensive research, Steve believes that Large Firm is soon going to make an offer to purchase Small Firm. If Steve wants to earn the highest return possible from this information, he should purchase shares of _____ Firm.

Small

An asset's adjusted present value is equal to the net present value of the project, assuming all equity financing, plus the present value of an other side effects, plus the ________. - present value of interest tax shields - present value of dividend tax shields - net present value of the project, assuming all-debt financing - net present value of the project, discounted at the WACC

- present value of interest tax shields

When estimating the discount rate for a project that is different from their firm, management may calculate the cost of capital for industries related to the new project. Ideally, they would like to find single-segment firms that only operate in that line of business. Such firms are known as _________. - private firms - pure-plays - diversified firms - conglomerates

- pure-plays

If a multi-segment firm uses a single cost of capital for all business segments, the low-risk segments will _________ while the high-rise segments will __________. - reject projects they should accepts; reject projects they should accept - reject projects they should accepts; accept projects they should reject - accept projects they should reject; accept projects they should reject - accept projects they should reject; reject projects they should accepts

- reject projects they should accepts; accept projects they should reject

which of the following are examples of indirect costs of financing when debt levels are high? - suppliers without trade credit -employees leave to work at other firms -a competitor starts a price war -sales fall due to lost customers -lawyer fees for bankruptcy filing are high

- suppliers without trade credit -employees leave to work at other firms -a competitor starts a price war -sales fall due to lost customers

Since the investors should hold a diversified portfolio of securities, a rational investor should only be concerned with an investment's _______ risk. - total - systematic - unsystematic

- systematic

The beta of a stock is the measure of the stocks________ risk. - diversifiable - total - systematic - unsystematic

- systematic

When finding a value of a company with an infinite life, analysts typically evaluate the firm as having two discount growth periods. Zan analyst who finds the present value of the second mature-growth period has calculated the ________ value of the firm. - terminal - par - comparable tades - forecasted

- terminal

Which of the following are consequences of operating leverage? - More operating income is needed to cover fixed financial costs - the amount of profits after the breakeven point is reached increases - the amount of sales needed to break even increases - the risk of the firm is reduced

- the amount of profits after the breakeven point is reached increases - the amount of sales needed to break even increases

In theory, managers will always act in the best interest of shareholders because: - Shareholders will fire a manager if they believe that the manger is not maximizing shareholder wealth - managers always have a financial incentive to act in the shareholders' best interest - the manager's firm will cease to exist if she does not maximize value, due to competition - the board of directors gave the power to hire a fire management and will replace a poorly performing manager

- the manager's firm will cease to exist if she does not maximize value, due to competition - the board of directors gave the power to hire a fire management and will replace a poorly performing manager

The premium for control will never exceed: - the liquidation value of the acquiring firm - the liquidation value of the target firm - the present value of the future cash flows of the target firm (before enhancements) - the present value of all enhancements anticipated by the acquiring firm

- the present value of all enhancements anticipated by the acquiring firm

Annual tax savings from having debt financing is equal to ________ - the sum of interest expense and principle payments on the debt -the product of the amount of debt financing and the interest rate - the ratio of interest expense to pre-tax profits - the product of the tax rate and the interest expense

- the product of the tax rate and the interest expense

The present value of an investment's annual Economic Value Added (EVA) for every year of its existence will be _______ the net present value of a project, assuming the same discount rates. - the same as - less than - greater than

- the same as

When a merger takes place, the acquiring firm often purchases the target firm for a price higher than the value of a target firm's stock. This typically happens because: - managers are unable to accurately value target firms - there is a premium for control which is not reflected in the price of the stock - the excess price paid reflects the target firms goodwill, which is an intangible asset not on the balance sheet - shareholders int he acquiring firm do not actively participate in management decisions

- there is a premium for control which is not reflected in the price of the stock

A firms asset beta is commonly referred to as the firm's _________ beta and is the equity beta a firm would report is the firm was financed with __________. - levered; equity only - unlevered; equity only - levered; debt and equity - unlevered; debt and equity

- unlevered; equity only

The value of firms equity is equal to the _________. - value of the firm's debt less the value ion the firm - value of the firm plus the value of the firm's debt - value of the firm's assets less the value of the firms debt - value of the firm less the value of the firm's debt

- value of the firm less the value of the firm's debt

Beta can be estimated by regressing a stock's returns relative to returns on a _________ portfolio. Beta is the _________ of this simple regression line. - well-diversified; slope -non-diversifed; y-intercept - non-diversified; slope - well-diversified; y-intercept

- well-diversified; slope

Which of the following is a potential long-run consequence of issuing too much debt? -An inability to raise equity capital at all - An inability to reduce the dividend payout ratio on existing equity - An inability to raise capital at a reasonable price - An inability to purse attractive investment opportunities

-An inability to raise equity capital at all - An inability to raise capital at a reasonable price - An inability to purse attractive investment opportunities

In theory, a firms capital structure is irrelevant because investors in firm can choose the degree of leverage of their investment by ___________. This act is know as ________ leverage. -Using dividend to purchase additional shares; homemade -Using debt to purchase some of the firm's stock; homemade - Using debt to purchase some of he firm's stock; instant - Using dividends to purchase additional shares; instant

-Using debt to purchase some of the firm's stock; homemade

If firms follow the pecking order approach to financing, what is the order of financing options that the firm will follow ( most preferred to least) - Internal sources of financing - Equity financing - Debt financing

1. Internal sources of financing 2. Debt financing 3. Equity financing

The firms wishes to minimize the risk and expected return on an investment, then they should finance with_______ (debt or equity)

Equity

There is general agreement that the purpose of the firm's financing decision should be to increase________.

Firm Value

One way to account for an investment risks is to use the risk-adjusted discount rate. This means the discount rate used for a project should _________ as the risk of the projects cash flows increase. - Remain the same - Decrease - Increase

Increase

Buying a share of stock gives you some ______ in a company. The ability to have a say in a company operations is known as _______

Ownership; control

The cost of capital (is/is not)_______ a risk-adjusted discount rate

is