Ch 9 & 10 Corporate Finance

In 2008, the prices on long-term U.S. Treasury bonds __________ . -gained 40% -gained 20% -lost 40% -were unaffected

-gained 40%

Investment in net working capital arises when ___ (Select all that apply).

-inventory is purchased -credit sales are made -cash is kept for unexpected expenditures

Which of the following are reasons why NPV is considered a superior capital budgeting technique? (Select all that apply) -It considers time value of money. -It considers all the cash flows. -It properly chooses among mutually exclusive projects -It considers the riskiness of the project.

-It considers time value of money. -It considers all the cash flows. -It properly chooses among mutually exclusive projects -It considers the riskiness of the project.

What are the two main drawbacks of sensitivity analysis? (Select all that apply) -It does not consider interaction among variables. -It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. -It is easy to compute. -It considers the effects of interactions among variables.

-It does not consider interaction among variables. -It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive.

What are the two main benefits of performing sensitivity analysis? (Select all that apply) -It is easier to perform than conventional NPV analysis. -It identifies the variable that has the most effect on NPV. -It makes it possible to make a correct decision every time. -It reduces a false sense of security by giving a range of values for NPV instead of a single value.

-It identifies the variable that has the most effect on NPV. -It reduces a false sense of security by giving a range of values for NPV instead of a single value.

Identify the three main sources of cash flows over the life of a typical project. (Select all that apply) -Net cash flows from sales and expenses over the life of the project -Cash outflows from investment in plant and equipment at the inception of the project -Net cash flows from salvage value at the end of the project

-Net cash flows from sales and expenses over the life of the project -Cash outflows from investment in plant and equipment at the inception of the project -Net cash flows from salvage value at the end of the project

What is scenario analysis? -Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario. -Scenario analysis determines the impact on NPV of a change in a single variable. -Scenario analysis determines the probability of occurrence of various future events that could affect the project. -Scenario analysis maps out the various steps involved in the manufacturing process.

-Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.

Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset? (Select all that apply) -There will be a tax savings if the book value exceeds the sales price. -Book value represents the purchase price minus the accumulated depreciation. -Taxes are based on the difference between the book value and the sales price. -Taxes are based on the difference between the purchase price and sales price of the asset.

-There will be a tax savings if the book value exceeds the sales price. -Book value represents the purchase price minus the accumulated depreciation. -Taxes are based on the difference between the book value and the sales price

The Ibbotson-Sinquefield data shows that: (Select all that apply) -U.S. T-bills had the lowest risk or variability -large common stocks had higher returns than small common stocks -long-term corporate bonds had less risk or variability than stocks -inflation was always higher than the T-bill yield

-U.S. T-bills had the lowest risk or variability -long-term corporate bonds had less risk or variability than stocks

Percentage returns are more convenient than dollar returns because they: (Select all that apply) -allow comparison against other investments -apply to any amount invested -are more accurate than dollar amounts -avoid using the dollar sign

-allow comparison against other investments -apply to any amount invested

The possibility that errors in projected cash flows will lead to incorrect decisions is known as: (Select all that apply) -forecasting risk -estimation risk -managerial incompetence -guess and bless

-forecasting risk -estimation risk

The goals of risk analysis in capital budgeting include: (Select all that apply) -identifying critical components -determining the correct discount rate -zeroing in on the correct NPV -assessing the degree of financing risk

-identifying critical components -assessing the degree of financing risk

Estimates of which of the following are needed to prepare pro forma income statements? (Select all that apply) -unit sales -historical trends -competitor pricing -variable costs -selling price per unit

-unit sales -variable costs -selling price per unit

if a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be -charged against the project again. -ignored. -50% reversed. -100% reversed.

100% reversed

The rules for depreciating assets for tax purposes are based upon provisions in the: 1986 IRS Act 1986 SEC Act 1986 Tax Reform Act 1986 Sarbanes-Oxley Act

1986 tax reform act

Bonds used in Ibbotson SBBI long-term U.S. government bond portfolio had maturities of ____ years. -10 -30 -20 -15

20

The probability of a return being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent. -68 -34 -99 -95

68

From 1900 to 2010, the average stock market risk premium of the U.S. was ______. -9.8% 5.9% 7.2%

7.2%

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 -An overreaction and correction -A delayed reaction

-An efficient market reaction

A positive capital gain on a stock results from ___. -a decrease in price -an increase in the dividend -an increase in price -an increase in the coupon rate

-an increase in price

The year 2008 was: -one of the best years for stock market investors in U.S. history -an average year for the stock market -one of the worst years for stock market investors in U.S. history

-one of the worst years for stock market investors in U.S. history

If you use an arithmetic average to project long-run wealth levels, your results will most likely be _______. -optimistic -pessimistic -lower but close to right -about right

-optimistic

Which of the following are fixed costs? (Select all that apply) -net working capital -inventory costs -rent on a production facility -cost of equipment

-rent on a production facility -cost of equipment

Using capital market history as a guide, it would appear the greatest reward would come from investing in _______. -small-company common stock -long-term corporate bonds -long-term government bonds -large-company common stocks

-small-company common stock

The Ibbotson SBBI data show that over the long-term, ___. (Select all that apply) -long-term corporate bonds had the lowest risk -small-company stocks generated the highest average return -large-company stocks generated the highest average return -T-bills, which had the lowest risk, generated the lowest return -small-company stocks had the highest risk level

-small-company stocks generated the highest average return -T-bills, which had the lowest risk, generated the lowest return -small-company stocks had the highest risk level

Studying market history can reward us by demonstrating that: (Select all that apply) -the stock market is nothing but a casino -the greater the potential reward is, the lower the risk -the greater the potential reward is, the greater the risk -there is a reward for bearing risk

-the greater the potential reward is, the greater the risk -there is a reward for bearing risk

Which of the following is commonly used to measure inflation? -The Case-Schiller Index (CSI) -The Dow Jones Industrial Average (DJIA) -The Consumer Price Index (CPI) -The CBOE Volatility INdex (VIX)

CPI

True or false: Taxes are based on the difference between the initial cost and the sales price

False

A positive NPV exists when the market value of a project exceeds its cost. Which of these two values is the most difficult to establish? -Both are easy to establish -Both are difficult to establish -Market value -Project cost

Market Value

Which of the following techniques will provide the most consistently correct result? -Internal Rate of Return -Average Accounting Return -Payback -Net Present Value

NPV

Which type of stock price adjustment time path occurs when there is a bubble (price run up) in the path followed by a decline after the market receives information about the stock? -Overreaction and correction -Delayed reaction -Efficient market reaction

Overreaction and correction

What approach does the following formula describe? OCF = (Sales - Costs) x (1-TC) + Depreciation x TC

The tax shield approach

True or false: If analysts are overly optimistic about the future, then they may accept a project that realistically has a negative NPV.

True

More volatility in returns produces ______ difference between the arithmetic and geometric averages. - a larger -a smaller -no change in the

a larger

Cash flows should always be considered on a(n) ___________ basis.

after-tax

In an efficient market ______ investments have a _____ NPV. -most; zero all; positive all; zero most; positive most; negative

all;zero

The dividend yield for a one-year period is equal to the annual dividend amount divided by the ____. -average of the beginning and ending stock prices -ending stock price -beginning stock price

beginning stock price

Opportunity costs are ____. -the actual expenses incurred by a firm to preserve its market share -the actual expenses of pursuing a specific project -benefits gained as a result of accepting a particular project -benefits lost due to taking on a particular project

benefits lost due to taking on a particular project

_______ were a bright spot for U.S. investors during 2008. -Stocks trading on the Icelandic Exchange -Preferred stocks -Bonds -Common stocks

bonds

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

cannot be observed

The geometric average return is the average ____________ return earned per year over a multiyear period.

compund

The ________ price index is a commonly used measure of inflation

consumer

What is net working capital?

current assets - current liabilities

Historically, there is a(n) ______ relationship between risk and expected return in the financial markets. -inverse -indirect -direct -stagnant

direct

In an efficient market, firms should expect to receive ______ value for securities they sell. -less than fair -fair -more than fair

fair

Because T-bills have low risk relative to common stocks, T-bills cannot outperform common stocks

false

Percentage returns are difficult to use for comparisons because they depend on the dollar amount invested.

false

The capital gains yield = (Pt+1 - Pt)/Dt

false

Sunk costs are costs that ___ -relate to other projects of the firm -cannot be measured -have already occurred and are not affected by accepting or rejecting a project -will not contribute to profits in

have already occurred and are not affected by accepting or rejecting a project

If we find that our estimated NPV is sensitive to a variable that is difficult to forecast, then the degree of forecasting risk is _____.

high

If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____. -is highly risky -has a low level of risk -is risk-free

highly risky

Interest expenses incurred on debt financing are ______ when computing cash flows from a project.

ignored

An efficient market is one in which any change in available information will be reflected in the company's stock price ___. -at least within a week -in a day -immediately -in two days

immediately

Dividends are the ______ component of the total return from investing in a stock. -income -capital gains -price appreciation -amortization

income

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in ______________.

net working capital

The difference between a firm's current assets and its current liabilities is known as the _____. -long-term capital -net working capital -net opportunity capital -capital structure

net working capital

In the Ibbotson-Sinquefield studies, U. S. Treasury bill data is based on T-bills with a maturity of _______ month(s). -nine -three -six -one

one

The most valuable alternative that is given up if an investment is undertaken is called what?

opportunity cost

Normally, the excess rate of return is ___. -positive -Zero -negative

positive

The risk ____________ can be interpreted as the reward for bearing risk.

premium

Historically, the real return on Treasury bills has been: -misunderstood -negative -quite low -quite high

quite low

Given a level of investment in net working capital, that same investment must be _________ at some time in the future.

recovered

Opportunity costs are classified as ____ costs in project analysis.

relevant

An unrealized gain is treated the same as a realized gain when computing the total ________.

return

The excess return is the difference between the rate of return on a risky asset and the ______ rate -federal funds -prime -inflation -risk-free

risk-free

_________ analysis is useful in pinpointing variables that deserve the most attention.

sensitivity

The depreciation tax _________ is the tax savings that results from the depreciation deduction.

shield

Geometric averages are usually ______ arithmetic averages. -the same as -smaller than -larger than

smaller than

The variance and its square root, the ____________, are the most commonly used measures of volatility.

standard deviation

Some important characteristics of the normal distribution are that it is: -very "bumpy" and not smooth -bell-shaped -skewed to the right -symmetrical

symmetrical

The geometric average rate of return is approximately equal to ___. -half the arithmetic mean minus half of the variance -half of the arithmetic average plus half of the standard deviation -the arithmetic mean plus half of the standard deviation -the arithmetic mean minus half of the variance

the arithmetic mean minus half of the variance

True or false: Investment in net working capital may arise from the need to cover credit sales.

true

the dividend yield = Dt+1/Pt

true

The percentage change in the price of a stock over a period of time is called its ___________. -growth yield -price change yield -capital gain yield -total return

-capital gain yield

Which of the following are ways to make money by investing in stocks? (Select all that apply) -Amortization Capital gains Interest Dividends

-capital gains -dividends

Side effects from investing in a project refer to cash flows from (Select all that apply): -Sunk costs -Opportunity -erosion -Beneficial spillover effects

-erosion effects -beneficial spillover effects

The dividend yield minus the capital gains yield is the total return percentage.

false

To get the average return, the yearly returns are summed and then multiplied by the number of returns.

false

True or false: Fixed costs cannot be changed over the life of the investment.

false

True or false: In calculating cash flows, you should consider all financing costs.

false

True or false: Operating cash flow is based on the salvage value of equipment.

false

True or false: Sensitivity analysis is helpful because it indicates what we should do regarding forecasting errors.

false

True or false: Taxes are based on the difference between the initial cost and the sales price.

false

Roger Ibbotson and Rex Sinquefield presented year-to-year historical rates of return on ________ types of financial investments.

five

An increase in depreciation expense will ____ cash flows from operations.

increase

The difference between a firm's cash flows with a project versus without the project is called ________________. -additional cash flows -incremental cash flows -differential cash flows -net cash flows

incremental cash flow

stock prices fluctuate from day to day because of: -conspiracies -bad news -manipulators -information flow

information flow

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: -ending stock price -dividend yield -cost of capital -initial stock price

initial stock price

To get the average, or ________ return, the yearly returns are summed and then divided by the number of returns.

mean

In order to analyze the risk of a project's NPV estimate, we should establish ___________ for each important estimate variable.

upper and lower bounds

The square of the standard deviation is equal to the ____. -Sharpe ratio -mean -median return -variance

variance

If a study of past stock prices and volume to find mis-priced securities will not lead to gains in the market, then the market must be at least _____ efficient. -semi-strong form -strong form -weak-form

weak-form

The basic approach to evaluating cash flow and NPV estimates involves asking:

what-if questions

Which of the following are considered relevant cash flows? (Select all that apply) -Cash flows from erosion effects -Cash flows from beneficial spillover effects -Cash flows from sunk costs -Cash flows from external costs

-Cash flows from erosion effects -Cash flows from beneficial spillover effects -Cash flows from external costs

Which of the following are components of project cash flow? (Select all that apply) -Change in net working capital -Operating cash flow -Capital spending -Change in Fixed assets

-Change in net working capital -Operating cash flow -Capital spending

Operating cash flow is a function of: (Select all that apply) -Salvage Value of Equipment -Earnings Before Interest and Taxes -Initial Investment in Equipment -Taxes -Depreciation

-Earnings Before Interest and Taxes -Taxes -Depreciation

Once cash flows have been estimated, which of the following investment criteria can be applied to them? (Select all that apply) -IRR -payback period -NPV -YTM -the constant growth dividend discount model

-IRR -payback period -NPV

What is the total number of inputs that change at a given time while doing sensitivity analysis?

1

If a firm's variable cost per unit estimate used in its base case analysis is $50 per unit and they anticipate the upper and lower bounds to be +/- 10%, What is the "worst case" for variable cost per unit?

55$

The project cash flow equals the project operating cash flow _________ project change in NWC minus project capital spending.

minus