Finance Test 3

Which one of the following is an example of a sunk cost?

$1,200 paid to repair a machine last year

Dependable Motors just purchased some MACRS 5-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for years 1 to 3, respectively. Which one of the following will correctly give you the book value of this equipment at the end of year 2?

$216,000 (1 - .2 - .32)

P.A. Petroleum just purchased some equipment at a cost of $67,000. The equipment is classified as MACRS 5-year property. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for years 1 to 6, respectively. What is the proper methodology for computing the depreciation expense for year 2?

$67,000 .32

How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio?

10

What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average?

16 percent

Which one of the following time periods is associated with low rates of inflation?

2010-2013

The average annual return on small-company stocks was about _______ percent greater than the average annual return on large-company stocks over the period 1926-2013

5

Based on the period 1926-2013, the actual real return on large-company stocks has been around:

8.3

The systematic risk of the market is measured by:

A beta of 1.0

Which one of the following indicates a portfolio is being effectively diversified?

A decrease in the portfolio standard deviation

Which one of the following is the best example of a diversifiable risk?

A firm's sales decrease

Forecasting risk emphasizes the point that correctness of any decision to accept or reject a project is highly dependent upon the:

Accuracy of the projected cash flows

Which one of the following statements best defines the efficient market hypothesis?

All securities in an efficient market are zero net present value investments

The depreciation tax shield is best defined as the:

Amount of tax that is saved because of the depreciation expense

Which one of the following would make mutually exclusive project unacceptable?

An equivalent annual cost that exceeds that of an alternative project

Systematic risk is measured by:

Beta

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?

Beta

What was the highest annual rate of inflation during the period 1926-2013?

Between 15-20 percent

What was the average rate of inflation over the period of 1926-2013?

Between 2.8 and 3.2 percent

Assume you invest in a portfolio of U. S. Treasury bills and that the portfolio will earn a rate of return similar to the average return on U.S. Treasury bills for the period 1926-2013. What rate of return should you expect to earn?

Between 3 and 4 percent

Which of the following statements are true based on the historical record for 1926-2013?

Bonds are generally a safer investment than are stocks

Changes in the net working capital requirements:

Can affect the cash flows of a project every year of the project's life

Unsystematic risk:

Can be effectively eliminated by portfolio diversification

The standard deviation of a portfolio:

Can be less than the standard deviation of the least risky security in the portfolio

The standard deviation of a portfolio:

Can be less than the weighted average of the standard deviations of the individual securities held in that portfolio

The operating cash flow of a cost-cutting project:

Can be positive even though there are no sales

Net working capital:

Can create either an initial cash inflow or outflow

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

Capital asset pricing model

Which one of the following yields on a stock can be negative?

Capital gains yield and total return

Bell Weather Goods has several proposed independent projects that have positive NPVs. However, the firm cannot initiate any of the projects due to a lack of financing. This situation is referred to as:

Capital rationing.

Which one of the following is an example of unsystematic risk?

Consumer spending on entertainment decreased nationally

If the variability of the returns on large-company stocks were to decrease over the long-term, you would expect which one of the following to occur as a result?

Decrease in the 68 percent probability range of returns

The net book value of equipment will:

Decrease slower under straight-line depreciation that under MACRS

Sensitivity analysis determines the:

Degree to which the net present value reacts to changes in a single variable

Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow?

Depreciation expense

Scenario analysis is defined as the:

Determination of changes in NPV estimates when what-if questions are posted

Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions?

Efficient capital markets

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

Either stock A is over priced or stock B is underpriced or both

The primary purpose of portfolio diversification is to:

Eliminate asset-specific risk

Which one of the following statements is correct concerning unsystematic risk?

Eliminating unsystematic risk is the responsibility of the individual investor

Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs and machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision?

Equivalent annual cost

Which one of the following best describes pro forma financial statements?

Financial statements showing projected values for the future time periods

Which of the following variables will be forecast at their highest expected level under a worst case scenario?

Fixed and variable costs

The average compound return earned per year over a multiyear period is called the ________ average return.

Geometric

Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?

Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

As the degree of sensitivity of a project to a single variable rises, the:

Greater is the importance of accurately predicting the value of that variable

PC Enterprises wants to commence a new project but is unable to obtain the financing under any circumstances. This firm is facing:

Hard rationing

Which of the following statements concerning risk are correct? I. Non diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

The expected return on a portfolio considers which of the following factors? I. Percentage of the portfolio invested in each individual security. II. Projected states of the economy. III. The performance of each security given various economic states. IV. Probability of occurrence for each state of the economy.

I, II, III, and IV

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. Asset's standard deviation. II. Asset's beta. III. Risk-free rate of return. IV. Market risk premium.

II and IV only

Forecasting risk is defined as the possibility that:

Incorrect decisions will be made due to erroneous cash flow projections

To convince investors to accept greater volatility, you must:

Increase the risk premium

The stand-alone principle that advocates that project analysis should be solely on which of the following costs?

Incremental

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it doesn't accept the project is referred to as the project's:

Incremental Cash flows

All of the following are related to a proposed project. Which one of these should be included in the cash flow at Time 0?

Initial investment in inventory to support the project

The operating cash flow for a project should exclude which one of the following?

Interest expense

Which one of the following is an example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

Is underpriced

As long as the inflation rate is positive, the real rate of return on a security will be ______ the nominal rate of return

Less than

You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines that have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine that has the:

Lowest equivalent annual cost

Individual investors who continually monitor the financial markets seeking mispriced securities:

Make the markets increasingly more efficient

Which one of the following is represented by the slope of the security market line?

Market risk premium

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

Market risk premium and the amount of systematic risk inherent in the security

Which one of the following should NOT be included in the analysis of a new product?

Money already spent on research and development of the new product

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero?

Net income + Depreciation

Which one of the following correctly describes the dividend yield?

Next year's annual dividend divided by today's stock price

Which one of the following is best defined by its mean and its standard deviation?

Normal distribution

Which one of the following statements is correct?

Over time, the average unexpected return will be zero

The primary purpose of Blume's formula is to:

Project future rates of return

Which one of the following is the least apt to reduce the unsystematic risk of a portfolio?

Reducing the number of stocks held in the portfolio

The excess return is computed as the:

Return on a risky security minus the risk-free rate

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

Reward-to-risk ratio

Last year, T-Bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return?

Risk Premium

The expected risk premium on a stock is equal to the expected return on the stock minus the:

Risk-free rate

Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using?

Scenario Analysis

Which one of the following statements concerning scenario analysis is correct?

Scenario analysis helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions.

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

Security Market line

A firm's managers realize they cannot monitor all aspects of their projects but do want to maintain a constant focus on the key aspect of each project in an attempt to maximize their firm's value. Given this specific desire, which type of analysis should they require for each project and why?

Sensitivity analysis; to identify the key variable that affects a project's profitability

An analysis that combines scenario analysis with sensitivity analysis is called _____________ analysis

Simulation

Which one of the following earned the highest risk premium over the period 1926-2013?

Small-company stocks

The historical record for the period 1926-2013 supports which one of the following statements?

Small-company stocks have lost as much as 50-percent and gained as much as 100 percent in a single year

Small-company stocks, as the term is used in the textbook, are defined as the:

Smallest twenty percent of the firms listed on the NYSE

Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as:

Soft Rationing

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

Strong

Inside information has the least value when financial markets are:

Strong form efficient

The market risk premium is computed by:

Subtracting the risk-free rate of return from the market rate of return

G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?

Sunk

Which one of the following costs was incurred in the past and cannot be recouped?

Sunk

Which one of the following statements concerning U.S. Treasury bills is correct for the period 1926- 2013?

The annual rate of return was always positive

Which one of the following best defines the variance of an investment's annual returns over a number of years?

The average squared difference between the actual returns and the arithmetic return

Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $.75 in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive

Which one of the following best describes the concept of erosion?

The cash flows of a new project that came at the expense of a firm's existing cash flows.

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semi strong form efficient.

The information was expected

The bottom-up approach to computing the operating cash flow applies only when:

The interest expense is equal to zero

The intercept point of the security market line is the rate of return which corresponds to:

The risk-free rate

Which one of the following categories of securities had the lowest average risk premium for the period of 1926-2013?

U.S. Treasury Bills

Which one of the following statements correctly applies to the period 1926-2013?

U.S. Treasury Bills had a positive average real rate of return

Which one of the following had the least volatile annual returns over the period of 1926-2013?

US treasury bills

Which one of the following statements is a correct reflection of the US markets for the period of 1926-2013?

US treasury bills provided a positive rate of return each and every year during the period

Which one of the following statements related to unexpected returns is correct?

Unexpected return can either be positive or negative in the short term but tend to be zero over the long-term

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by 20 percent. What type of risk does this news flash best represent?

Unsystematic

Which one of the following risks is irrelevant to a well-diversified investor?

Unsystematic risk

The equivalent annual cost method is useful in determining:

Which one of two machines should be purchased when the machines are mutually exclusive, have different lives, and will be replaced at the end of their lives.

Simulation analysis is based on assigning a ________ and analyzing the results

Wide range of values to multiple variables simultaneously

When you assign the highest anticipated sales price and the lowest anticipated costs to a project, you are analyzing the project uner the condition known as:

Worst case scenario analysis

Which one of the following is most indicative of a totally efficient stock market?

Zero net present values for all stock investments

Which one of the following is a project cash flow? Ignore any tax effects

decrease in accounts receivable

Which one of the following statements is correct concerning bid prices?

A firm can submit a bid that is higher that the computed bid price and still break even

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it issues new shares of stock if the market is efficient

A stock with an actual return that lies above the security market line has:

A higher return than expected for the level of risk assumed

The expected return on a stock computed using economic probabilities is:

A mathematical expectation based on a weighted average and not an actual anticipated outcome

Which one of the following statements is correct concerning a portfolio beta?

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio

Which one of the following statements is correct?

A project can create a positive operating cash flow without affecting sales

Which one of the following is the depreciation method that allows accelerated write-offs of the property under various lifetime classifications?

ACRS

Which one of the following statements related to capital gains is correct?

An increase in an unrealized capital gain will increase the capital gains yield

Which one of the following will increase a bid price?

An increase in the required rate of return

The return earned in an average year over a multiyear period is called the __________ average return

Arithmetic

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

Cost of capital

The equivalent annual cost considers all of the following except:

Cost of research conducted to identify equipment choices

Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share to $1.50 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price:

Decreased proportionately with the dividend decrease

Assume you are considering two mutually exclusive machines and need to select one for a cost-cutting project. Which one of these sets of characteristics best indicates the use of the equivalent annual cost method of analysis?

Differing lives and planned replacement at end of life

Decreasing which one of the following will increase the acceptability of a project?

Equivalent annual cost

The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?

Equivalent annual costs

Which one of the following is most directly affected by the level of systematic risk in a security?

Expected rate of return

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

Expected return

The CFO of Edward's Food Distributors is continually receiving capital funding requests from its division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is:

Facing hard rationing

Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

Hiring additional employees to handle the increased workload should the firm accept the wreath project

Which one of the following is an example of diversifiable risk? I. Earthquake damages an entire town. II. Federal government imposes a $100 fee on all business entities III. Employment taxes increase nationally. IV. Toymakers are required to improve their safety standards.

I and IV only

The expected return on a portfolio: I. Can never exceed the expected return of the best performing security in the portfolio. II. Must be equal to or greater than the expected return of the worst performing security in the portfolio. III. Is independent of the unsystematic risks of the individual securities held in the portfolio. IV. Is independent of the allocation of the portfolio amongst individual securities.

I, II, III only

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in 30 unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II, III only

The capital asset pricing model (CAPM) assumes which of the following? I. A risk-free asset has no systematic risk. II. Beta is a reliable estimate of total risk. III. The reward-to-risk ratio is constant. IV. The market rate of return can be approximated.

I, III, IV only

Generally speaking, which of the following most correspond to a wide frequency distribution? I. relatively low risk II. relatively low rate of return III. relatively high standard deviation IV. relatively large risk premium

III and IV

Scenario analysis is best suited to accomplishing which one of the following when analyzing a project?

Identifying the potential range of reasonable outcomes

The top-down approach to computing the operating cash flow:

Ignores noncash expenses

Pro forma statements for a proposed project should generally do all of the following except:

Include interest expense

Evidence seems to support the view that studying public information to identify mispriced stocks is:

Ineffective

The base case values used in the scenario analysis are the values considered to be the most:

Likely to occur

Which one of the following statements is correct based on the historical record for the period 1926-2013?

Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds.

Which one of the following statements is correct based on the period 1926-2013?

Long-term government bonds had more volatile annual returns than did the long term corporate bonds

Which one of the following is a correct ranking of securities based on the volatility of their annual returns over the period of 1926-2013? Rank from highest to lowest.

Long-term government bonds, long-term corporate bonds, intermediate-term government bonds

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

Market value of the investment in each stock

Which one of the following statements related to market efficiency tends to be supported by current evidence?

Markets tend to respond quickly to new information

If a stock portfolio is well diversified, then the portfolio variance:

May be less than the variance of the least risky stock in the portfolio

The real rate of return on a stock is approximately equal to the nominal rate of return:

Minus the inflation rate

The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following?

Opportunity Cost

Estimates of the rate of return on a security based on the historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term.

Overestimate; underestimate

Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments?

Portfolio

Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following?

Portfolio weight

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

Risk premium

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

Risk premium

Three years ago, Knox Glass purchased a machine for a three-year project. The machine is being depreciated straight-line to zero over a five-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate)

Sale price + (Book value - Sale price) T

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

Selling fewer hot dogs because hamburgers were added to the menu.

Frank's is a furniture store that is considering adding appliances to its offerings. Which one of the following is the best example of an incremental cash flow related to the appliances?

Selling furniture to appliance customers

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.

Semi strong

An analysis of the change in a project's NPV when a single variable is changed is called ____________ analysis

Sensitivity

Which type of analysis identifies the variable, or variables, that are the most critical to the success of a particular project?

Sensitivity

Which one of the following types of analysis is the most complex to conduct?

Simulation

Which one of the following categories of security had the highest average return for the first period 1926-2013?

Small companies

Which one of the following categories of securities had the most volatile annual returns over the period 1926-2013?

Small company stocks

Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million. For the firm as a whole, management has limited spending to $10 million for new projects next year even though the firm could afford additional investments. This is an example of:

Soft Rationing

The procedure of allocating a fixed amount of funds for capital spending to each business unit is called

Soft rationing

The principle of diversification tells us that:

Spreading an investment across many diverse assets will eliminate some of the total risk

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

Stand-alone principle

Total risk is measured by ______ and the systematic risk is measured by _______.

Standard deviation; beta

Which one of the following should earn the most risk premium based on CAPM?

Stock with a beta of 1.38

Which one of the following is a risk that applies to most securities?

Systematic

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

Systematic principal

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

Tax due on the salvage value of that asset

Which one of the following will be used in the computation of the best-case analysis of a proposed project?

The lowest variable cost per unit that can be reasonably expected

Efficient financial markets fluctuate continuously because:

The markets are continually reacting to new information

The bid price is:

The minimum price that will provide your target rate of return.

The bid price always assumes which one of the following?

The net present value of the project is zero

Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its five-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income. Given this, which one of the following statements is correct?

The new machine will generate positive operating cash flows.

Assume you graph a project's net present value given various quantities. Which one of the following is correct regarding the resulting function?

The slop of the function measures the sensitivity of the net present value to a change in sales quantity

Which one of the following statements related to risk is correct?

The systematic risk portfolio can be effectively lowered by adding T-Bills to the portfolio

Which one of the following events would be included in the expected return on Sussex stock?

This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.

Standard deviation measures which type of risk?

Total

Standard Deviation is a measure of which of the following?

Volatility

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst?

Weak

The expected return on a stock given various states of the economy is equal to the:

Weighted average of the returns for each economic state

A company that utilizes the MACRS system of depreciation:

Will have a greater depreciation tax shield in year 2 than in year 1