FIN Exam 4 (Ch 11, 13, 14)
Which of the following are true?
- Ideally, we should use market values in the WACC - Book values are often similar to market values for debt.
Which of the following are examples of fixed costs for a car repair shop performing oil changes and other repairs?
- Insurance for the shop - Salary for the shop manager - Monthly rent for the shop
Which of the following are true about depreciation expense?
- It affects the accounting profit break-even point - It affects cash flows - It is a non-cash expense
What are the two main drawbacks of sensitivity analysis?
- It does not consider integration among variables - It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive
What does variance measure?
- It measures the riskiness of a security's returns - It measures the spread of the sample of returns
Which of the following are reasons why and NPV is considered a superior capital budgeting technique?
- NPV considers all the cash flows - NPV considers time value of money
Which of the following are true about variable costs?
- The variable cost per unit may remain constant as the number of units produced increases - Total costs increase as the total number of units produced increases
According to the CAPM, which of the following events would affect the return on a risky asset?
- a strengthening of the country's currency - a change in the yield on T-bills - federal reserve actions that affect the economy
A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?
- an increase in the corporate tax rate - an increase in the federal funds rate
Which of the following are components used in the construction of the WACC?
- cost of debt - cost of preferred stock - cost of common stock
Which costs are included in the numerator of the accounting profit break-even point equation?
- depreciation - fixed costs
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
The possibility that errors in projected cash flows will lead to incorrect decisions is known as:
- estimation risk - forecasting risk
Which of the following are examples of a portfolio?
- holding $100,000 investment in a combination of stocks and bonds - investing $100,000 in a combination of US and Asian stocks - investing $100,000 in the stocks of 50 publicly traded corporations
What are the two main benefits of performing sensitivity analysis?
- it identifies the variable that has the most effect on NPV - it gives a range of values for NPV instead of single value, so that gives a more realistic picture.
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
- it may eventually be almost totally eliminated - it is likely to decrease
The SML approach requires estimates of
- market risk premium - beta coefficient
To estimate a firm's equity cost of capital using the CAPM, we need to know the ______
- market risk premium - risk-free rate - stock's beta
A firm's cost of debt can be _____.
- obtained by checking yields on publicly traded bonds - estimated easier than its cost of equity - obtained by talking to investment bankers
Preferred stock ____.
- pays a constant dividend - pays dividends in perpetuity
The rate used to discount project cash flows is known as the _____.
- required return - discount rate - cost of capital
A firm faces many risk. Which of the following are examples of unsystematic risks faced by a firm?
- the death of a CEO - a hostile takeover attempt by a competitor
What are the two components of the expected return on the market?
- the risk premium - the risk-free rate
What are the two components of unexpected return (U) in the total return equation?
- the unsystematic portion - the systematic portion
The risk of owning an asset comes from:
- unanticipated events - surprises
_____ risk is reduced as more securities are added to the portfolio
- unsystematic - unique - diversifiable
To estimate the growth rate of a particular stock, we can ______.
- use the historical dividend growth rate - use security analyst's forecasts
CHAPTER 13
.
The risk-free asset has a beta of:
0
According the weighted average cost of capital (WACC) formula, a firm with no debt or preferred stock will have a WACC of:
1 x Cost of equity
What is sunk cost?
A cost incurred in the past that is irrelevant to the capital investment decision process
What will the shapes of total revenue and total cost be on the graph that depicts number of units on axis and dollar amount (revenues and cost) on the Y axis?
Both the total revenue and total cost curves will slope upward
Which of the following defines the contribution margin per unit?
Contribution Margin per Unit = Sales price - Variable cost per unit
Sigma Corporation consists of two divisions: A and B. Division A is riskier than Division B. If Sigma Corporation uses the firm's overall WACC to evaluate both Division's projects, which Division will probably not receive enough resources to fund all of its potentially profitable projects?
Division B
The CAPM formula is:
E(Re)=Rf+B(E(Rm)-Rf)
True or false: Projects should always be discounted at firm's overall cost of capital
False
What does the security market line depict?
It is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta.
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets
What is an uncertain or risky return?
It is the portion of return that depends on information that is currently unknown.
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 of the following is an example of a sunk cost?
Research and development expense incurred in the past
The market risk premium is defined as:
Rm-Rf
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 time
Which of the following is an opportunity costs in the context of a vacant building that a firm currently owns?
The potential rental income loss by using the empty building for a project
Which one of the following is true?
Under US tax law, a corporation's interest payments are tax-deductible
The discount rate for the firm's projects equals the cost of capital for the firm as a whole when ___
all projects have the same risk as the current firm
From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage
as low as possible
A firm will start generating positive accounting profits
beyond the break-even sales point
WACC is used to discount ______ _________.
cash flows
The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the:
cost of capital
Which of the following are tax-deductible to the firm?
coupon interest paid on bonds
The increase in the number of stocks in a portfolio results in a(n) _____ in the average standard deviation of annual portfolio returns.
decrease
To apply the dividend growth model to a particular stock, you need to assume that the firms ___ will grow at a constant rate
dividend
The return an investor in a security receives is ______ ______ the cost of the security to the company that issued it.
equal to
If Kellogg's introduces a new brand of cereal, it will most likely lead to ____ in its sales of existing cereals.
erosion, i.e., a decrease
What two factors determine a stock's total return?
expected return and unexpected return
The issuance costs of bonds and stocks are referred to as _____ costs.
flotation
A firm with higher operating leverage will have _____ fixed costs relative to a firm with low operating leverage.
high
If the variance of a portfolio increases, then the portfolio standard deviation will _________
increase
In reality, most firms cover the equity portion of their capital spending with _____.
internally generated cash flow
If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be:
positive
If an all-equity firm discounts a projects cash flows with the firms overall weighted average cost of capital even though the projects beta is less than the firms overall beta, it is possible that the project might be:
rejected, when it should be accepted
It would be useful to understand how the _________ of the risk premium on a risky asset is determined
size
When an investor is diversified only ______ risk matters.
systematic
What type of risk does not change as we add more securities to a portfolio?
systematic, or market, risk
The systematic risk principle argues that that market does not reward risks:
that are borne unnecessarily
When a project breaks even on an accounting basis, the cash flow for that period will equal:
the depreciation allowance for that period
Which of the following methods for calculating the cost of equity ignores risk?
the dividend growth model
What is the intercept of the security market line (SML)?
the risk-free rate
The contribution margin per unit will increase if _____.
the sales price per unit increases while the variable cost per unit decreases
How are the unsystematic risks of two different companies in two different industries related?
there is no relationship
Finding a firm's overall cost of equity is difficult because:
there is no way of directly observing the return that the firms equity investors require on their investment
If a firm uses its overall cost of capital to discount cash flows from higher risk projects, it will accept ____ projects.
too many high-risk
In a competitive market, positive NPV projects are:
uncommon
What does WACC stand for?
weighted average cost of capital
The basic approach to evaluating cash flow and NPV estimates involves asking:
what-if questions
A good source for bond quotes is:
www.finra.org/marketdata