Corporate Finance Chapter 6, 7 & 8

54. Opportunity costs should not be included in project analysis, as they are missed opportunities.

FALSE

54. The distribution of annual returns over long periods for stocks is more closely related to the normal distribution than the lognormal distribution.

FALSE

54. Treasury bills typically provide higher average returns, both in nominal terms and in real terms, than long-term government bonds.

FALSE

56. For log normally distributed returns, the annual geometric average return is greater than the arithmetic average return.

FALSE

56. If two investments offer the same expected return, then most investors would prefer the one with higher variance.

FALSE

57. By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.

FALSE

58. A financial analyst should include interest and dividend payments when calculating a project's cash flows.

FALSE

58. Investors mainly worry about those risks that can be eliminated through diversification.

FALSE

58. The standard statistical measures of the variability of stock returns are beta and covariance

FALSE

60. The portfolio risk that cannot be eliminated by diversification is called unique risk.

FALSE

61. In theory, the CAPM requires that the market portfolio consist of only common stocks.

FALSE

61. Within the MACRS system of depreciation, most industrial equipment falls into the 10-15 year classes.

FALSE

63. Almost all tests of the CAPM have confirmed that it explains stock returns, especially for high-beta stocks.

FALSE

63. The average beta of all stocks in the market is zero.

FALSE

64. A portfolio with a beta of one offers an expected return equal to the market risk premium.

FALSE

64. The arbitrage pricing theory (APT) implies that the market portfolio is efficient.

FALSE

64. The rule for comparing machines with different lives is to select the machine with the greatest equivalent annual cost (EAC).

FALSE

65. Stocks with high standard deviations will necessarily also have high betas.

FALSE

66. Low standard deviation stocks always have low betas.

FALSE

67. The equivalent annual cash-flow technique is primarily used whenever the lives of two different projects are the same.

FALSE

68. By purchasing U.S. government bonds, an investor can achieve both a risk-free nominal rate of return and a risk-free real rate of return.

FALSE

70. One can easily calculate the estimated risk premium on stocks via the statistical analysis of historical stock returns.

FALSE

71. The standard deviation of a two-stock portfolio generally equals the value-weighted average of the standard deviations of the two stocks.

FALSE

73. Risk-free U.S. Treasury bills have a beta greater than zero.

FALSE

74. Underpriced stocks will plot below the security market line.

FALSE

76. The variability of a well-diversified portfolio mostly reflects the contributions to risk from the standard deviations of the stocks within that portfolio.

FALSE

77. Overpriced stocks will plot above the security market line.

FALSE

53. The distribution of daily returns over short periods for stocks is more closely related to the normal distribution than the lognormal distribution.

TRUE

53. When calculating cash flows, one should consider all incidental effects.

TRUE

55. A risk premium is the difference between a security's return and the Treasury bill return.

TRUE

55. If the expected return of stock A is 12 percent and that of stock B is 14 percent, and both have the same variance, then nondiversified investors would prefer stock B to stock A.

TRUE

55. Working capital is needed for additional investment within a project and should be included within cash-flow estimates.

TRUE

56. Sunk costs are bygones (i.e., they are unaffected by the decision to accept or reject a project). They should therefore be ignored.

TRUE

57. According to the authors, a reasonable range for the risk premium in the United States is 5 percent to 8 percent.

TRUE

57. Portfolios that offer the highest expected return for a given variance (or standard deviation) are known as efficient portfolios.

TRUE

59. Beta measures the marginal contribution of a stock to the risk of a well-diversified portfolio.

TRUE

59. Depreciation expense acts as a tax shield in reducing taxes.

TRUE

59. Diversification reduces the risk of a portfolio because the prices of different securities do not move exactly together.

TRUE

60. According to the CAPM, all investments plot along the security market line.

TRUE

60. Working capital is one of the most common sources of mistakes in estimating project cash flows.

TRUE

61. The portfolio risk that cannot be eliminated by diversification is called market risk.

TRUE

62. According to the CAPM, the market portfolio is a tangency portfolio.

TRUE

62. Most large U.S. corporations keep two separate sets of books, one for stockholders and one for the Internal Revenue Service.

TRUE

62. The beta of a well-diversified portfolio is equal to the value weighted average beta of the securities included in the portfolio.

TRUE

63. A financial analyst can use the equivalent annual cash-flow approach to determine the year in which an existing machine can be profitably replaced with a new machine.

TRUE

65. Both the CAPM and the APT stress that unique risk does not affect expected return.

TRUE

65. You should replace a machine when the EAC of continuing to operate it exceeds the EAC of the new machine.

TRUE

66. It is not possible to earn a return that is above the efficient frontier of common stocks without the existence of a risk-free asset or some other asset that is uncorrelated with your portfolio assets.

TRUE

66. When evaluating mutually exclusive projects with positive NPV but different life spans, the proper technique to employ is the equivalent annual cash-flow approach.

TRUE

67. A stock having a covariance with the market that is higher than the variance of the market will always have a beta above 1.0.

TRUE

67. In addition to common stocks, the addition of real estate (as an investment alternative) will likely expand the efficient frontier to a better risk-return trade-off.

TRUE

68. Most investors dislike uncertainty.

TRUE

69. A risk premium generated by comparing stocks to 10-year U.S. Treasury bonds will be smaller than a risk premium generated by comparing stocks to U.S. Treasury bills.

TRUE

69. On an expected return versus standard deviation diagram (with expected return on the vertical axis), most investors prefer portfolios that appear more towards the top and the left.

TRUE

70.The correlation between the return on a risk-free asset and the return on any common stock will equal zero.

TRUE

71. All else equal, investors prefer to choose from portfolios having higher Sharpe ratios.

TRUE

72. Risk-free U.S. Treasury bills have a beta of zero.

TRUE

72. The covariance between the returns on two stocks equals the correlation coefficient multiplied by the standard deviations of the two stocks.

TRUE

73. For the most part, stock returns tend to move together. Thus, pairs of stocks tend to have both positive covariances and correlations.

TRUE

74. If returns on two stocks tended to move in opposite directions, then the covariances and correlations on the two stocks would be negative.

TRUE

75. Diversification can reduce portfolio risk even in the case when correlations across stock returns equal zero.

TRUE

75. Underpriced stocks will plot above the security market line

TRUE

76. Overpriced stocks will plot below the security market line.

TRUE

77. The risk of a well-diversified portfolio depends on the market risk of the securities included in the portfolio.

TRUE