Finance Exam #3
The change in a firm's future cash flows that results from adding a new project are referred to as _____ cash flows
incremental
Which one of the following is the best example of systematic risk?
inflation exceeding market expectations
The cost of preferred stock
is equal to the preferred stock's dividend yield
Systematic risk
is measured by beta
The cost of capital for a project is primarily determined by the project's
level of risk
A security's risk premium is equal to the
market rate minus the inflation rate
In an efficient market, a security with a beta of 1.03 will have a rate of return that plots:
on the SML just to the right of the market return
The percentage of a portfolio's value that is represented by a single security is referred to as the
portfolio weight
A pro forma financial statement is a financial statement that
projects future years' operations
Using the weighted average cost of capital (WACC) of another firm as the required return for a project is referred to as the
pure play approach
Diversifying a portfolio across various sectors and industries will tend to
reduce the firm-specific risk.
An unexpected return is a return that
results from a surprise announcement or event
The cost of equity for ABC Industries is defined as the:
return that ABC's shareholders require on their investment in the firm
The positive linear function depicting the relationship between beta and the expected return is called the
security market line
The analysis of the effect that a single variable has on the net present value of a project is called _____ analysis
sensitivity
Which one of the following represents the key weakness of the dividend growth model?
sensitivity of the model to the rate of dividend growth
If the risk-free rate of return decreases while the market rate of return remains constant, then the
slope of the security market line will increase
The situation that exists when the units within a business are allotted a fixed amount of money for capital budgeting is referred to as
soft rationing
Beta = 1
stock has average risk
Beta > 1
stock is greater than average
Beta < 1
stock with less than average risk
What is the name given to the process of assigning discount rates to projects by utilizing a stair step method that assigns projects to various risk classes?
subjective approach
A U.S. depreciation system that allows for more rapid depreciation under various classifications is called
the accelerated cost recovery system
The concept of investing in a variety of diverse assets to reduce risk is referred to as
the principle of diversification
Beta Measures
- Amount of systematic risk present in a particular risky asset relative to that in an average risky asset
The opportunity to modify a project in the future is referred to as
A managerial option
Systematic Risk
A risk that influences a large number of assets. Also, market risk.
The most valuable alternative that is forfeited if a particular investment is undertaken is called
An opportunity cost
The situation a firm faces when it has positive net present value projects but cannot obtain financing for those projects is referred to as
Capital rationing
The cash flows of a new project that result from a reduction in the cash flows from a firm's existing projects are called
Erosion
When a firm cannot raise financing for a project under any circumstances, the firm is facing a situation known as
Hard Rationing
The analysis of the effects that what-if questions have on the net present value of a project is called _____ analysis
Scenario
The assumption that a project will be evaluated based on its incremental cash flows is referred to as the
Stand-alone principle
The options a firm has to expand into related business products are referred to as
Strategic options
The risk premium for a security is based on which one of the following types of risk?
Systematic
standard deviation
a computed measure of how much scores vary around the mean score
A sunk cost is
a cost that has already been incurred and cannot be recouped
Systematic risk is
a risk that affects a large number of assets
unsystematic risk
a risk that affects at most a small number of assets. Also, unique or asset-specific risk
Which one of the following best exemplifies unsystematic risk?
an unexpected increase in the sales of a firm
he equation that is represented graphically by the security market line is called the:
capital asset pricing model
Which one of the following is the primary determinant of the cost of capital for a proposed project?
combined sources of funds used to finance the project
The return that lenders require on a firm's borrowed funds is called the firm's
cost of debt
The weighted average cost of capital is defined as the weighted average of a firm's
cost of equity and its aftertax cost of debt
A change in a firm's tax rate will not affect the firm's after-tax cost of
equity
The return on a risky asset that is anticipated in the future is called the
expected return
A portfolio is a(n)
group of assets held by an investor
The cost of capital for a project depends primarily on the
use of the funds
DL Industries just called a press conference and is now announcing that the firm is restructuring and will be closing two manufacturing facilities. This announcement:
will have no effect on the firm's stock price if the announcement was expected
All else constant, an increase in a firm's cost of debt
will result in an increase in the firm's cost of capital