Finance 3090
An NYSE member who executes customer buy and sell orders is called a ______broker.
floor
Which of the following is an example of a sunk cost?
Research and development expense incurred in the past
All of the following are disadvantages of the Payback Period, except:
The method incorporates the time value of money.
What will the impact be on your risk exposure if your bond has recently been categorized as a "fallen angel"?
Your risk will increase.
A bond with exotic features is often called a _____ bond.
cat
The total dollar return on a stock is the sum of the ____ and the _____.
dividends; capital gains
The square of the standard deviation is equal to the ____.
variance
The _________ curse says that the lowest bidder is the one who underbid the most.
winner's
The __________ gains yield can be found by taking the difference between the ending stock price and the initial stock price and dividing it by the initial stock price.
capital
If you buy a stock for $10 and later sell it for $16, you will have a ____.
capital gain of $6
The sales level that results in a zero operating cash flow is called the
cash break-even
The cash flows of a new project that come at the expense of a firm's existing projects is called _________________.
erosion
The profitability index is calculated by dividing the PV of the _________ cash flows by the initial investment.
future
Average returns can be calculated using __________ or arithmetic average.
geometric
More volatility in returns produces ______ difference between the arithmetic and geometric averages.
larger
Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ______________ are overlooked.
net working capital
__________ returns tell how much was received for each dollar invested, so they can be applied to any initial investment amount.
percentage
The second lesson from capital market history is that there is a direct link between __________ and reward
risk
Geometric averages are ______ arithmetic averages.
smaller than
In a _____ board, only a fraction of the directorships are up for election at any one time.
staggered
What are some features of the OTC market for bonds?
~The OTC has no designated physical location. ~OTC dealers are connected electronically.
A benchmark PE ratio can be determined using:
~a company's own historical PEs ~the PEs of similar companies
What does a Moody's bond rating of C typically indicate?
The issuer is in default
What does the dirty price represent?
The price of a bond including accrued interest, also known as the full or invoice price. This is the price the buyer actually pays.
The internal rate of return is a function of ____.
a project's cash flows
The assumption of constant growth infers that _________.
dividends change at a constant rate
Operating cash flow is a function of _____.
earnings before interest and taxes depreciation taxes
A bond with a BBB rating has a ______ than a bond with an A rating.
higher risk of default
Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
ignored (In analyzing a proposed investment, we will _not_ include interest paid or any other financing costs such as dividends or principal repaid because we are interested in the cash flow generated by the assets of the project)
A market is considered transparent if ____.
its prices and trading volume are easily observed
Blume's formula combines _____.
the arithmetic average return and the geometric average return
What will the shapes of total revenue and total costs be on a graph that depicts number of units on the x-axis and dollar amount (revenues and cost) on the y-axis?
Both the total revenue and total cost curves will slope upward.
What is the likely impact on all interest rates when the real rates are high?
It will increase
An NYSE member who acts as a dealer in particular stocks is called a _________ market maker.
designated
In a simulation, the average NPV and the spread of NPVs around the average are determined by _____.
repeated random drawings
The ___________ principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.
stand-alone
Which of the following represents the accounting profit break-even point?
(Fixed costs + Depreciation)/Contribution margin
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
_____________ analysis uses a combination of scenario and sensitivity analysis.
Simulation
What does historical data suggest about the nature of short-term and long-term interest rates?
Sometimes short-term rates are higher and sometimes long-term rates are higher.
True or false: In general, the stock market is more transparent than the real estate market.
True
True or false: It can be advantageous to have a staggered board because it provides "institutional memory."
True
Which of the following are mutually exclusive investments?
Two different choices for the assembly lines that will make the same product. A restaurant or a gas station on the same piece of land.
Sunk costs are costs that ____.
have already occurred and are not affected by accepting or rejecting a project
The CPI is the most commonly used measure of __________ .
inflation
One reason corporations use staggered boards is that _____.
it makes takeover attempts less likely to be successful
A normal distribution has a ______ shape.
symmetrical
Using the discounting approach, calculate the MIRR of the following cash flows: Assume that the required return on this project is 15% Project A Initial Cost -$ 50 Year 1 $ 175 Year 2 -$ 115
27.74%
_________ formula is the equation that combines the arithmetic average return and the geometric average return
Blume's
NASDAQ has which of these features?
Computer network of securities dealers Multiple market maker system
Financial break-even is the sales level that results in _____.
an NPV of zero
Based on the _______ payback rule, an investment is acceptable if its ______________ payback is less than some prespecified number of years.
discounted discounted
As the time to maturity increases, the interest rate risk premium ____.
increases at a decreasing rate
Most voting in large corporations is done by proxy because _____.
most small shareholders do not attend the annual meeting
The ____________ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment.
payback
The amount of time needed for the cash flows from an investment to pay for its initial cost is the _____ period.
payback
Erosion will ______ the sales of existing products.
reduce
Corporate managers care about the break-even point because it indicates the level to which _____ can fall before a project will start losing money.
sales
In case of default:
subordinated debt holders must give preference to other specified creditors
When a project breaks even on an accounting basis, the cash flow for that period will equal _____.
the depreciation allowance for that period
Opportunity costs are ____.
benefits lost due to taking on a particular project
Initial public offerings of stock occur in the ____ market.
primary
The accelerated cost _______________ system is a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.
recovery
In general, which will have a higher pretax yield? (Assume the bonds are comparable.)
A corporate bond
Which of the following occurs in the primary market?
Newly-issued stocks are initially sold
Which of the following is a fixed cost for a garment manufacturing business?
Rent for the building
A firm's bond rating sheds light on its _________ risk.
default
The Sharpe ratio measures ___.
reward to risk
Stock prices fluctuate from day to day because of _____.
information flow
What information do we need to determine the value of stock using the zero-growth model?
Discount rate Annual dividend amount
In a competitive market, positive NPV projects are:
uncommon
What does the Modified Internal Rate of Return (MIRR) assume?
The MIRR assumes that cash flows will be reinvested at the cost of capital.
_______ were a bright spot for U.S. investors during 2008.
Bonds
Which of the following equations correctly relates OCF to sales volume?
OCF = (P − v) × Q − FC
If a given set of cash flows is expressed in ______ terms and discounted at the _____ rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the real rate.
nominal; nominal
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
The standard deviation is the ______ of the variance.
square root
If you are forecasting a few decades in the future (as you might do for retirement planning) you should calculate the expected return using:
Blume's formula
With ______ bonds, the coupon payments are adjustable.
Floating-rate
_____________ cash flows come about as a direct consequence of taking a project under consideration.
Incremental
According to Graham and Harvey's 1999 survey of 392 CFOs, in addition to IRR and NPV, which were the two most widely used techniques, over half of the respondents always, or almost always, used which of the following methods?
Payback method
The Discounted Payback Period Rule states that a company will accept a project if:
The calculated payback is less than a pre-specified number of years.
The Payback Period Rule states that a company will accept a project if:
The calculated payback is less than a pre-specified number of years.
What is crossover rate?
The discount rate at which we are indifferent between two investments.
What is the first step when calculating the crossover rate?
To calculate the cash flow differences between each project.
What is the purpose of accounting profit break-even analysis?
To determine the level of sales at which profits are equal to zero.
The present value of all cash flows (after the initial investment) is divided by the ______ to calculate the profitability index.
initial investment
How has TRACE improved transparency in the corporate bond market?
Corporate bond dealers are now required to report trade information through TRACE.
A ______ is a payment by a corporation to shareholders, made in either cash or stock.
dividend
The __________ the risk, the greater the required return.
greater
The second lesson from studying capital market history is that risk is _____.
handsomely rewarded
In general, the arithmetic average return is probably too _____ for longer periods and the geometric average is probably too _____ for shorter periods.
high; low
As a practical matter, it is easier to __________operating leverage than it is to ___________.
increase decrease
For all practical purposes, it is easier to _____.
increase operating leverage than to decrease it
The term structure of interest rates is determined by the real rate of interest, the interest rate risk premium, and the _____ premium.
inflation
An efficient market is one that fully reflects all available ______.
information
If the IRR is greater than the _______ ________, we should accept the project.
required return
What are three important features of Treasury notes and bonds?
~Highly liquid ~Taxable ~Default-free
The rates of return in the Ibbotson-Sinquefield studies are not adjusted for which of the following?
~Inflation ~Taxes
If you were classified as a high income/high tax bracket investor, you might find municipal bonds an attractive investment because ____.
income from municipal bonds is exempt from federal taxes
According to the approximation formula for the nominal rate of return (R), the nominal rate will ________ if inflation (h) increases.
increase
The three components of the Treasury yield curve include the real rate, expected future ______, and the interest rate risk premium.
inflation
The degree to which a firm or project relies on fixed costs is called the __________ leverage
operating
Which approach to estimating the operating cash flows uses the following equation? OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate
Tax shield approach
Contribution margin refers to the contribution made toward paying _____ by each additional unit sold.
fixed costs
Dividends are the ______ component of the total return from investing in a stock.
income
Normally, the excess rate of return on risky assets is ___.
positive
Which of the following are true?
~T-bills sometimes outperform common stocks. ~Common stocks may experience negative returns.
According the video, one of the biggest challenges for the Net Present Value method is:
Identifying the appropriate discount rate to use.
The Internal Rate of Return (IRR) represents which of the following:
The discount rate that makes the net present value equal to zero.
In an inflationary environment, the nominal rate will be _________ the real rate.
greater than
Which of the following are expected cash flows to investors in stocks?
Capital gains Dividends
Simpson Corporation expects to sell the following number of units of their newest product: Year Unit Sales 1 8,000 2 9,000 3 12,000 4 15,000 The revenue per unit is $180. NWC starts out at $50,000, then rises to 15% of sales. What is the change in cash flow for the NWC balance at the end of year 2?
$27,000
What is the formula to determine the price of a U.S. Treasury bond listed at 122 if the par value is $5,000?
$5,000 × 122%
Suppose you buy a share of stock for $100. At the end of one year the stock price is $114 and a $1 dividend is paid. If you do not sell the stock, your total annual return is ____.
15% (Reason: Even though the capital gain is not realized, it is still included in the annual return. ($114 - 100 + 1)/$100 = 15%)
Based upon the following data: calculate the crossover rate. Project A Project B Year 0 -1,000 -1,200 Year 1 600 700 Year 2 650 805
16.5%
What is net working capital?
Current assets minus current liabilities
What is the equation for estimating operating cash flows using the top-down approach?
OCF = Sales - Costs - Taxes
Suppose Price per Unit is $6, variable cost per unit is $2, fixed costs are $400 and the depreciation allowance per year is $500. The relationship between operating cash flow (OCF) and sales volume (Q) can be expressed as:
OCF = −400 + 4*Q
The dividend yield for a 1-year period is equal to the annual dividend amount divided by the ______.
beginning stock price
Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ____.
dealer
Corporate managers care about the break-even point because it indicates the level _____.
to which sales can fall before a project will start losing money
The idea for _____-stage growth is that the dividend will grow at a rate of g1 for t years and then grow at a rate of g2 thereafter, forever.
two
The coupon rate on an original issue discount bond will be ___.
very low
When choosing between mutually exclusive projects, what is the best method to use?
The highest NPV is always the best option.
The formula for valuing a constant growth stock is _____.
P0 = D1/(R − g)
The ______price excludes interest accrued since the last coupon payment, while the _____ price includes accrued interest.
Clean - Dirty
__________ analysis is the investigation of what happens to NPV when only one variable is changed.
SENSITIVITY
True or false: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.
True
From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage _____.
as low as possible
To be considered good, projected cash flows should _____ actual cash flows.
be close to
Capital ______ is the decision-making process for accepting and rejecting projects.
budgeting
The total dollar return is the sum of dividends and __________.
capital gains or losses
The geometric rate of return takes ______ into account.
compounding
True or false: The MIRR function eliminates multiple IRRs and should replace NPV.
false
The _________ break-even is the sales level that results in a zero NPV.
financial
The ___________ break-even is the sales level that results in a zero NPV
financial
The possibility that errors in projected cash flows will lead to incorrect decisions is called __________, or estimation , risk.
forecasting
One way to visually depict the dispersion of returns over a period of time is through a _____.
frequency distribution
Investment in net working capital arises when _________.
inventory is purchased credit sales are made cash is kept for unexpected expenditures
If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____.
is highly risky
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
The taxability premium is the additional compensation demanded on ____.
taxable bonds
Using the top-down approach, OCF is calculated by subtracting costs and __________ from sales.
taxes
Average returns can be calculated _____.
two different ways
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
The excess return on a risky asset is the difference between the risky return and the ____ rate.
risk-free
The cash break-even is the sales level that results in a ______ operating cash flows.
zero
Three special case patterns of dividend growth include _____.
~nonconstant growth ~zero growth ~constant growth
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds _____.
a target average accounting return
Which one of these correctly specifies the relationship between the nominal rate and the real rate?
(1 + R) = (1 + r) × (1 + h)
The rates on financial securities are generally quoted as _____ rates.
nominal
The rates on financial securities are generally quoted as ______ rates.
nominal
If a given set of cash flows is expressed in ________ terms and discounted at the _______ rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the real rate.
nominal; nominal
What are the three components of the Treasury yield curve?
~Expected inflation ~Interest rate risk premium ~Real rate of return
What are some reasons why the bond market is so big?
~Federal government borrowing activity in the bond market is enormous. ~Various state and local governments also participate in the bond market. ~Many corporations have multiple bond issues outstanding.
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
~Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. ~Treasury bonds are issued by the US government while corporate bonds are issued by corporations. ~Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.
Poplar products is evaluating a piece of machinery. The cost of the machinery is $1,700,000. The machinery will be depreciated over five years. At the end of the project, the equipment will be worth 25% of its original value. The tax rate is 35%. What is the after-tax proceeds at the end of the project?
$276,250 It will cost $1,700,000 to buy the equipment to begin. The equipment will be worth 25% of its cost at the end of the project ($1,700,000 × .25 = $425,000). At this time, the equipment will be fully depreciated. The relevant tax rate is 35%. Thus, the after-tax proceeds are $425,000 × (1 − .35) = $276,250.
If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit?
An efficient market reaction
True or false: The inflation premium will be higher if the rate of inflation is low.
False
What is the nominal rate of return on an investment?
It is the rate that has not been adjusted for inflation.
All of the following are commonly cited reasons for using the Internal Rate of Return, except:
Multiple IRR's allow the company to choose the best one when evaluating projects.
Which of the following are true about variable costs?
The variable cost per unit may remain constant as the number of units produced increases.
True or false: Based on the discounted payback rule, an investment is acceptable if its discounted payback is less than some prespecified number of years.
True
True or false: Cash flows should always be considered on an aftertax basis.
True
True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.
True
True or false: The crossover rate is the rate at which the NPVs of two projects are equal.
True
True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.
True
True or false: The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.
True
True or false: Ultimately, we are more interested in cash flow than accounting income.
True
True or false: When a business does hard rationing, the firm's DCF analysis breaks down.
True
True or false: When developing cash flows for capital budgeting, it is easy to overlook important items.
True
One of the only bright spots in investing during 2008 was that, while stocks plunged, U.S. Treasury __________ soared
bonds
An efficient market is one in which any change in available information will be reflected in the company's stock price ___.
immediately
An increase in depreciation expense will ____ cash flows from operations.
increase
Based on the historical returns shown in the text, the average __________ was 2.9 percent per year over the 97-year span depicted.
inflation
The _____ premium is the portion of a nominal interest rate that represents compensation for expected future ____.
inflation; inflation
The capital gains 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
Stock price reporting has increasingly moved from traditional print media to the ______ in recent years.
internet
Stock price reporting has increasingly moved from traditional print media to the in ______ recent years.
internet
An asset's class established its ____________ for tax purposes.
life
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
When the stock being valued does not pay dividends,
the dividend growth model can still be used.
The Fisher effect decomposes the nominal rate into:
the inflation rate and the real rate
Phantom Corporation purchased equipment for $50,000, four years ago. The accumulated depreciation to date is $41,360. If they were able to sell the equipment today for $20,000, what would be the amount of tax due? Assume the company is in the 34% tax bracket.
$3,862 Original cost $50,000 Less: accumulated depreciation $41,360= Book value $8,640Sales price $20,000Less: Book value $8,640= Proceeds $11,360Proceeds $11,360 × Tax rate 34% = Tax due $3,862
Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.
$400,000
Dusty Corporation has an issue of preferred stock that pays a dividend of 7 percent of its state value, which is $100. Which of the following would be a commonly used name for that preferred stock?
$7 preferred
The basic NPV investment rule is:
- reject a project if its NPV is less than zero - if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference - accept a project if the NPV is greater than zero
If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your after-tax yield change if your income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes
0%
Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $1,000,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of $_____ as the base case.
1,000,000
Arrange the steps involved in the discounted payback period in order starting with the first step.
1. Discount the cash flows using the discount rate. 2. Add the discounted cash flows. 3. Accept if the discounted payback period is less than some pre-specified number of years.
ased upon the following data: calculate the Profitability Index. Cost = $325 Present value of future cash flows = $350
1.08
A projected IRR on a risky investment in the _____ percent range is not unusual.
10 to 20
Preferred shares have a stated liquidating value, typically $_____ per share.
100
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ____ percent.
12
Based upon the following data: calculate the Average Accounting Return Net Income: Year 1: $ 1,500,000 Year 2: $ 1,200,000 Year 3: $ 1,050,000 Year 4: -$ 1,400,000 Year 5: $ 1,350,000 The starting book value is $11,840,000, which will end with $0, at the end of five years.
12.5%
Based on average historical returns shown in the text, small-company stocks increased in value by _____ percent in a typical year.
16
The rules for depreciating assets for tax purposes are based upon provisions in the ___.
1986 Tax Reform Act
During the financial crisis of 2008, the S&P 500 Index fell by _____ percent.
37
If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.
5%
The probability of an outcome being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent.
68
If an investment appreciates by 7 percent while the rate of inflation is 2 percent, what is the nominal rate of return?
7%; The nominal rate is the observed rate - in this case the appreciation is the observed rate. It includes inflation.
If the rate of inflation is 3 percent and the real rate of return is 5 percent, the nominal rate is approximately ____ percent.
8
The probability of an outcome being within ± two standard deviations of the mean in a normal distribution is approximately ____ percent.
95
Which one of the following is the equation for estimating operating cash flows using the tax shield approach?
= (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
What is a sunk cost?
A cost incurred in the past that is irrelevant to the capital investment decision process.
What are municipal bonds?
Bonds that have been issued by state or local governments
_______________ budgeting is the decision-making process for accepting and rejecting projects.
Capital
Which of the following are ways to make money by investing in stocks?
Capital gains Dividends
True or false: If you invest in junk bonds, there is a high likelihood that you will earn a very high return.
False
Based upon the following data, which of the following mutually exclusive projects should you choose if your required return is 10%? Year Investment A Investment B 0 −$ 150 −$ 150 1 80 40 2 40 50 3 40 60 4 30 55
Investment B with an NPV of $10.33
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 a real rate of return?
It is a rate of return that has been adjusted for inflation.
While making capital budgeting decisions, which of the following sentence is true regarding the initial investment of net working capital?
It is expected to be recovered by the end of the project's life.
Which of the following are reasons why NPV is considered a superior capital budgeting technique?
NPV considers time value of money. NPV considers all the cash flows.
WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?
No minority shareholder would have enough votes to win any seat on the board.
When considering Net Working Capital, a project will generally need all of the following, except:
Only long term assets to get the project started
What are the federal income tax implications of receiving $50 in interest income from a municipal bond versus a corporate bond?
Only the interest on the corporate bond will be taxed.
This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.
Payback method
In the Ibbotson study, the large-company common stock portfolio is based on the ____.
S&P 500 Index
_________ analysis involves estimating the best-case, worst-case, and base-case cash flows and calculating the corresponding NPVs.
Scenario
True or false: A capital gain on a stock is counted as part of the total return whether or not the gain is realized from selling the stock.
TRUE (An unrealized gain is treated the same as a realized gain when computing the total return.)
What does mutually exclusive mean?
Taking one project means that we cannot take the other.
Which of the following is an example of a sunk cost?
Test marketing expenses
Which of the following is commonly used to measure inflation?
The Consumer Price Index (CPI)
Which is the largest security market in the world in terms of trading volume?
The U.S. Treasuries market
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
The asked price The bid price
Which of the following entities declares a dividend?
The board of directors
When evaluating cost-cutting proposals, how are operating cash flows affected?
There is an additional depreciation deduction. The decrease in costs increases operating income.
What is the relationship between variable costs and output?
Total variable costs are directly related to the level of output.
A project should be __________ if its NPV is greater than zero.
accepted
Based on the average ____________ return rule, a project is acceptable if its average __________ return exceeds a target average _________________.
accounting accounting accounting
ash flows should always be considered on a(n) ___________ basis.
aftertax
When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in _____.
asking what-if questions scenario analysis
If a $1,000 face value U.S. Treasury bond is quoted at 85, then the bond can be purchased _____.
at 85 percent of face value plus any accrued interest
The average return on the stock market can be used to ___.
compare stock returns with the returns on other securities
A zero-growth model for stock valuation is distinguished by a ____.
constant dividend amount
If a bond is rated Baa by Moody's and BB by Standard & Poor's, the bond will be regarded as a(n) _____ bond.
crossover
The _________ rate is the rate at which the NPVs of two projects are equal.
crossover
To calculate the OCF using the bottom-up approach, add __________ to net income
depreciation
Historically, there is a(n) ______ relationship between risk and expected return in the stock market.
direct
Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.
direct
Preferred stock has preference over common stock in the _____.
distribution of corporate assets payment of dividends
Common stock as no special preference either in receiving _______ or in bankruptcy.
dividends
A 10-year AAA corporate bond is most apt to have a yield that ____ the yield on a 10-year AAA state government bond.
exceeds
In an efficient market, firms should expect to receive ______ value for securities they sell.
fair
The interest from a municipal bond is exempt from ____ income taxes.
federal
Which of the following is a conclusion that can be drawn regarding market efficiency from capital market history?
future market prices are hard to predict based on publicly available information
In terms of investments, the greater the potential risk, the __________ should be the expected return.
greater
A firm with higher operating leverage will have __________ fixed costs relative to a firm with low operating leverage.
high
The correlation between the real rate of interest and every interest rate is:
high
The payback period can lead to incorrect decisions if it is used too literally because it ____.
it ignores cash flows after the cutoff date
The _____ premium is the portion of a nominal interest rate or bond yield that represents compensation for lack of _____.
liquidity; liquidity
The computation of equivalent annual costs is useful when comparing projects with unequal _____.
lives
The interest rate risk premium is the additional compensation demanded by investors for holding ____ bonds.
longer-term
A zero coupon bond is a bond that ____.
makes no interest payments
With nonconventional cash flows, there is a possibility that more than one discount rate will make the NPV of an investment zero. This is called the __________ rates of return problem.
multiple
When applying two-stage growth, in the second stage, g2 _____.
must be less than R
By ignoring time value, the payback period rule may incorrectly accept projects with a _________ NPV.
negative
By ignoring time value, the payback period rule may incorrectly accept projects with a __________ NPV
negative
The difference between a firm's current assets and its current liabilities is known as the _____.
net working capital
The OTC has _____ designated physical location.
no
The IRR rule can lead to bad decisions when cash flows are _____ or projects are mutually exclusive.
not conventional
Evans Corporation estimated that the cash flows last year from a particular project would be $40,000, but the actual cash flow turned out to be $37,500. Evans Corporation should _____.
not expect cash flow estimates to be exactly right every time
The default risk premium refers to the extra compensation demanded by investors for the possibility that the issuer might ____.
not make all the promised payments
When voting for the board of directors, the number of votes a shareholder is entitled to is usually ______ vote per share held.
one
The year 2008 was _____.
one of the worst years for stock market investors in U.S. history
When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:
one vote per share held
A stock with dividend priority over common stock is called a __________ stock.
preferred
The interest rate risk _____ is the compensation investors demand for bearing interest rate risk.
premium
Net _________ value is a measure of how much value is created or added today by undertaking an investment.
present
In capital budgeting, the net ______ determines the value of a project to the company.
present value
The IRR rule can lead to bad decisions when _____ or _____.
projects are mutually exclusive cash flows are not conventional
A ______ is the grant of authority by a shareholder to someone else to vote his or her shares.
proxy
A fixed cost is a cost that _____.
remains constant as the level of business activity changes
Which of the following are fixed costs?
rent on a production facility cost of equipment
Internal rate of return (IRR) must be compared to the ________ in order to determine the acceptability of a project.
required return
The arithmetic average rate of return measures the ____.
return in an average year over a given period
The payback period method allows lower management to make__________, everyday financial decisions effectively.
smaller
The Omega Division of Alpha Corporation has been allocated $4 million for capital spending but has identified $4.6 million in positive NPV projects. Omega's manager thinks he can convince the company to fund the additional $0.6 million dollars because Omega uses _______ rationing to control overall spending.
soft
The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting is called __________ rationing
soft
The NYSE member who acts as a dealer in a small number of securities is called a(n) _____.
specialist
Within the context of financial markets, complete the following equation: Bid − Ask =
spread
Mota Motors has eight directors on its board, two of whom go up for election each year. This is an example of a:
staggered board
The goal of many successful organizations is a(n) ______ rate of growth in dividends.
steady
What is the first step in the Net Present Value (NPV) process?
step 1- estimate future cash flowsstep 2- calc pv of cash flowsstep 3- estimate/calc NPV
A capital gain on a stock results from an increase in ______.
stock price
With ______voting, the directors are elected one at a time and the only way to guarantee a seat is to own 50 percent plus one share.
straight
The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
suggests accepting
The point at which the NPV profile crosses the vertical axis is the:
sum of the cash flows of the project
The main reason for considering nonconstant growth in dividends is to allow for _____ growth rates over _____.
supernormal; some finite length of time
Based on the average accounting return rule, a project is acceptable if its average accounting return exceeds a __________ average accounting return.
target
The ______ premium is the portion of a nominal interest rate of bond yield that represents compensation for unfavorable _____ status
taxability: tax
Capital rationing exists when a company has identified positive NPV projects but can't find _____.
the necessary financing
A firm will start generating profits when ___.
the total number of units sold exceeds the accounting break-even point
The computation of equivalent annual costs is useful when comparing projects with _____ lives.
unequal
The ________ is equal to the quantity of output times the cost per unit of output.
variable cost
The probability of an outcome being within ± two standard deviations of the mean in a normal distribution is approximately ____ percent.
well-organized
The basic approach to evaluating cash flow and NPV estimates involves asking _________ questions
what-if
An accounting break-even point of 1,000 units means that ____.
when the firm sells 1,000 units, profits will be equal to zero
An accounting break-even point of 2,000 means the firm ____.
will start generating profits if it sells more than 2,000 units
Korporate Classics Corporation (KCC) won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the _____.
winner's curse
When analyzing a proposed investment, we _______ include interest paid or any other financing costs.
won't
A Treasury yield curve depicts the _____.
yields for different maturities of Treasury securities
Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:
zero
The IRR is the discount rate that makes the NPV of a project equal to ______.
zero
How significant is the inflation premium on the shape of the term structure of interest rates? (Select all that apply.)
~Very significant ~More significant than the real rate of return
Which of the following are features of common stock?
~It has no special preference in bankruptcy. ~It has no special preference in receiving dividends. ~It generally has voting rights.
Which of the following are features of municipal bonds?
~They are issued by state and local governments. ~The interest on municipal bonds is exempt from federal taxes.
The two potential ways to make money as a stockholder are through ______ and capital appreciation.
dividends
A firm with higher operating leverage will have ______ fixed costs relative to a firm with low operating leverage.
high
Which of the following are examples of variable costs for a grocery store?
the cost of labor to stock shelves the cost of vegetables
When dealing with the history of capital market returns, an average stock market return is useful because it ___.
~is the best estimate of any one year's stock market return during the specified period ~simplifies detailed market data
Studying market history can reward us by demonstrating that _____.
~on average, investors will earn a reward for bearing risk ~the greater the potential reward is, the greater the risk
Some important characteristics of the normal distribution are that it is:
~symmetrical ~bell-shaped
The three attributes of NPV are that it:
~uses cash flows. ~discounts the cash flows properly. ~uses all the cash flows of a project.
What are non-conventional cash flows?
A combination of cash outflows and inflows.
For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.
False
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
IRR payback period NPV
If a project has multiple internal rates of return, which of the following methods should be used?
MIRR NPV
Which is more transparent, the stock market or the bond market?
The stock market is more transparent.
The dividend __________ is defined as the annual dividend amount divided by the beginning stock price.
yield
True or false: With more than one class of common stock, it is easier for insiders such as founding families to maintain control of the company.
True
In a graph with output on the x-axis and dollar amount (for costs and revenues) on the y-axis, what will be the shapes of variable and fixed costs?
Variable costs will be upward sloping while fixed costs will be parallel to the x-axis
When McDonald's decides to build a new restaurant at a particular location, which of the following competitors might also be tempted to locate new facilities in the same area?
Wendy's Burger King
In the Ibbotson-Sinquefield studies, long-term corporate bonds have which of the following characteristics?
~High quality ~20-year maturities
Payback period tells the time it takes to break even in an ____ sense. Discounted payback period tells the time it takes to break even in an ______ or financial sense.
accounting; economic
Percentage returns are more convenient than dollar returns because they ____.
apply to any amount invested
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
at 99.5 percent of face value plus any accrued interest
How is investing in U.S. Treasury bonds different from investing in corporate bonds?
~Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not. ~Treasury issues have no default risk.
Which six factors determine the yield on a bond?
~Interest rate risk ~Default risk ~Taxability ~Real rate of return ~Expected future inflation ~Liquidity
Which three components determine the shape of the term structure of interest rates?
~Real interest rate ~Inflation premium ~Interest rate risk premium
Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?
~The life of a common stock is essentially forever. ~Common stock cash flows are not known in advance ~The rate of return required by the market is not easily observed.
According to the video, which of the following are disadvantages of the Average Accounting Return (AAR)?
~Time value of money is ignored. ~An arbitrary benchmark cutoff rate is established. ~Market values are not considered.
A person who brings buyers and sellers together is called a(n) ______.
broker
When a company declares a dividend, shareholders generally receive ______.
cash
NPV ______ cash flows properly.
discounts
Roger Ibbotson and Rex Sinquefield's research on historical rates of return _____.
does not adjust returns for inflation or taxes
A contribution margin of $35 means that ____.
each sale of an additional unit will contribute $35 toward paying fixed costs
When developing cash flows for capital budgeting, it is _____ to overlook important items.
easy
The discounted payback is the time it takes to break even in an ___________ or financial sense.
economic
An increase in depreciation expense will ________ cash flows from operations.
increase
Greater return volatility produces a __________ difference between the arithmetic and geometric averages.
larger
A share of common stock is ______ difficult to value in practice than a bond.
more
According to the basic IRR rule, we should _____.
reject a project if the IRR is less than the required return.
Opportunity costs are classified as ______ costs in project analysis.
relevant
The trading of existing shares occurs in the ______ market.
secondary
The __________ ratio is calculated as the risk premium of the asset divided by the standard deviation.
sharpe
A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____.
should be accepted if there is no capital rationing constraint
The _____ is the percentage change in operating cash flow relative to the percentage change in quantity sold.
DOL (degree of operating leverage)
Which of the following is the correct equation for the degree of operating leverage?
DOL = 1 + FC/OCF
The Average Accounting Return (AAR) Rule states that a company will accept a project that has an average account return that:
exceeds a pre-determined target average accounting return.
In an efficient market:
- All investments have NPV=0 - Assets are priced at the present value of their future cash flows
Based upon the following data: calculate the Discounted Payback Period with a discount rate of 10%. Project A Initial Cost -$ 50,000 Year 1 $ 20,000 Year 2 $ 25,000 Year 3 $ 20,000
2.74 years Correct
Based upon the following data: calculate the Payback Period. Project A Initial Cost -$ 50,000 Year 1 $ 20,000 Year 2 $ 15,000 Year 3 $ 20,000
2.75 years
Bonds used in Ibbotson-Sinquefield's long-term U.S. government bond portfolio had maturities of ____ years.
20
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
Which one of the following is true about dividend growth patterns?
Dividends may grow at a constant rate.
Which of the following represents the valuation of stock using a zero-growth model?
Dividends/Discount rate
What does the clean price for a bond represent?
The quoted price, which excludes interest accrued since the last coupon date.
The _________ step is to determine whether cash flows are relevant.
first
The possibility that errors in projected cash flows will lead to incorrect decisions is known as _____.
forecasting risk estimation risk
The situation that occurs when a business cannot raise financing for a project under any circumstances is called __________ rationing
hard
The point at which the NPV profile crosses the horizontal axis is the:
internal rate of return
One common reason for having two classes of common stock with different voting rights is _____.
it is easier for insiders such as founding families to maintain control of the company
The U.S. Treasuries market is the _____ in the world in terms of trading volume.
largest
The probability of an outcome being more than three standard deviations away from the mean in a normal distribution is approximately ___ percent.
less than 1
The Treasury yield curve plots the yields on Treasury notes and bonds relative to _______
maturity
A situation in which a firm has positive NPV projects but cannot find the necessary financing is called capital __________
rationing
If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ____ rate.
real
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
When assuming nonconstant growth in dividends, to avoid the problem of having to forecast and discount an infinite number of dividends, we must require that the dividends _____.
start growing at a constant rate sometime in the future
Kate Corporation has discovered a very secret new product, but hasn't yet announced the discovery to the public. If the stock price reacts before the announcement (assuming no corporate "leaks"), the market is _____ form efficient.
strong
When a firm finances new investments, it may set up accounts payable with suppliers, but the balance that the firm must supply is called the investment in net ______________ capital
working
How is a conventional bond different from a zero coupon bond?
~A conventional bond pays periodic interest whiles zeros make no interest payments. ~Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros must be offered at a discount from par
Match each information type to the form of market efficiency that identifies that type of information as being quickly and accurately reflected in stock prices.
~all information matches strong form efficiency ~strong form efficiency matches semistrong form efficiency ~historical stock prices matches historical stock prices
Which of the following are ways to make money by investing in stocks?
~dividends ~capital gains
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
Discounted payback period
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
What are the three components of the nominal rate of return?
~Compensation for the inflation effect on the original investment ~Compensation for the inflation effect on the investment earnings ~Real rate of return
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the United States?
~Net present value ~Internal rate of return
The Ibbotson-Sinquefield data shows that ___.
~U.S. T-bills had the lowest risk or variability ~long-term corporate bonds had less risk or variability than stocks
Which of the following defines the contribution margin per unit? Ignore taxes.
Contribution Margin per Unit = Sales price - Variable cost per unit
Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself of a board member that represents his interests?
Cumulative voting
True or false: Based on capital market history, market efficiency shows us that it is relatively simple to identify stocks that are incorrectly priced.
False
True or false: Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board.
False
Using the payback period rule will bias toward accepting which type of investment?
Short-term investmenTt
True or false: Interest earned on Treasury notes and bonds is taxable
TRUE
The combination approach for calculating the Modified Internal Rate of Return (MIRR) differs because:
Negative cash flows are discounted back and positive cash flows are compounded forward.
Which of the following statements is true in the context of comparing accounting profit and present value break-even point?
Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.
Corporate bond dealers are now required to report trade information through _____.
TRACE
A firm will start generating positive accounting profits _____.
beyond the break-even sales point
The price that represents what a dealer is willing to pay for a security is the _____.
bid price
The AAR is calculated by taking the average net income and dividing it by the average ____________ value.
book
OCF is calculated as net income plus depreciation using the _____ approach.
bottom-up
A situation in which taking one investment prevents the taking of another is called a mutually __________ investment decision.
exclusive
Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.
1. Small-company common stock 2. Long-term corporate bonds 3. US Treasury bills
Arrange the following investments in ascending order from lowest historical risk premium at the top to highest historical risk premium at the bottom.
1. US Treasury Bills 2. Long-term corporate stocks 3. Large-company stocks 4. Small-company stocks
What will happen to the default risk premium during periods of economic uncertainty?
It will increase.
Which of the following are examples of variable costs for a car manufacturer?
Labor costs The cost of steel Freight costs
How is an original issue discount bond (OID) different from a zero coupon bond?
An OID has a very low coupon rate, while a zero coupon bond pays no coupon.
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
What are "fallen angel" bonds?
Bonds that have dropped from investment grade to junk bond status
True or false: The real rate of return will generally be higher than the nominal rate of return.
False
What is accrued interest?
It is interest that has been earned but not yet received.
What is the asked price?
The asked price is the price at which a dealer is willing to sell.
Which has a higher value, the bid price quote or the asked price quote?
The asked price quote is higher.
True or false: In general, the price that is paid for a bond will exceed its quoted price.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True (Reason: Invoice price = Clean price + Accrued interest)
All junk bonds typically have which of these features?
`Less than investment-grade rating `High probability of default
When an investor sells a bond, the price received by a dealer is always the ____.
bid price
Secondary markets in sukuk are extremely illiquid because most sukuk are:
bought and held to maturity
One of the components of the nominal rate of return is the compensation for the _______effect on the original investment.
inflation
Interest on municipal bonds _____ federally taxed.
isn't
What are the cash flows involved in the purchase of a 5-year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
Pay $800 today and receive $1,000 at the end of 5 years
What is the difference between a bond's "clean price" and its "dirty price"?
The clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest.
How is the real rate of return different from the nominal rate of return?
The real rate of return is adjusted for the effect of inflation whereas nominal rate is not adjusted for the effect of inflation.
How is a zero coupon bond different from a conventional bond?
~Zero coupon bonds are always issued at a discount. ~Zero coupon bonds make no interest payments.
