EXAM 1-FIN 362
A calculated NPV of $15,000 means that the project is expected to create a positive value for the firm and _____.
should be accepted if there is no capital rationing constraint
The -alone principle is the assumption that evaluation of a project may be based on the project's incremental cash flows.
stand
The percentage of a portfolio's total value that is invested in a particular asset is the portfolio .
Blank 1: weight or weights
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets.
What is systematic risk?
It is a risk that pertains to a large number of assets.
According to the _________ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."
stand-alone Reason: According to the stand-alone principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."
When an investor is diversified only ________ risk matters.
systematic
Operating cash flow is a function of _____.
taxes earnings before interest and taxes depreciation
The systematic risk principle argues that the market does not reward risks _____.
that are borne unnecessarily
Studying market history can reward us by demonstrating that _____.
the greater the potential reward is, the greater the risk on average, investors will earn a reward for bearing risk
Once cash flows have been estimated, which of the following investment criteria can be applied to them?
IRR NPV payback period
Which of the following are examples of a portfolio?
Investing $100,000 in a combination of U.S. and Asian stocks Investing $100,000 in the stocks of 50 publicly traded corporations Holding $100,000 investment in a combination of stocks and bonds
Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.
$400,000
Which of the following are fixed costs?
-rent on a production facility -cost of equipment
By definition, what is the beta of the average asset equal to?
1
cash flows come about as a direct consequence of taking a project under consideration.
Blank 1: Incremental
returns tell how much was received for each dollar invested, so they can be applied to any initial investment amount.
Blank 1: Percentage or Percent
analysis determines the impact on NPV of a set of events relating to a specific situation.
Blank 1: Scenario
analysis involves estimating the best-case, worst-case, and base-case cash flows and calculating the corresponding NPVs. (Enter one word per blank.)
Blank 1: Scenario
The ratio is calculated as the risk premium of the asset divided by the standard deviation.
Blank 1: Sharpe
The coefficient is the amount of systematic risk present in a particular risky asset relative to that in an average asset.
Blank 1: beta
The gains yield can be found by taking the difference between the ending stock price and the initial stock price and dividing it by the initial stock price.
Blank 1: capital
To calculate the OCF using the bottom-up approach, add to net income.
Blank 1: depreciation
The _ return is the return that an investor will probably earn on a risky asset in the future.
Blank 1: expected
The (greater/lower) the risk, the greater the required return.
Blank 1: greater
A firm with higher operating leverage will have (low/high) fixed costs relative to a firm with low operating leverage.
Blank 1: high
A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are
Blank 1: inaccurate, wrong, or incorrect
The dividend is defined as the annual dividend amount divided by the beginning stock price.
Blank 1: yield or yeild
The principle of diversification tells us that, to a diversified investor, the only type of risk that matters is (systematic/unsystematic) risk.
Blank: systematic
Which of the following are examples of unsystematic risk?
Changes in management Labor strikes
The _____ is the percentage change in operating cash flow relative to the percentage change in quantity sold.
DOL
Which one of the following is the equation for estimating operating cash flows using the tax shield approach?
OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
What is the equation for estimating operating cash flows using the top-down approach?
OCF = Sales - Costs - Taxes
Which of the following is an example of a sunk cost?
Research and development expense incurred in the past
What is scenario analysis?
Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.
Which of the following is an opportunity cost in the context of a vacant building that a firm currently owns?
The potential rental income lost by using the empty building for a project
If we conclude that a project has a negative NPV when the true NPV is positive, we lose a valuable opportunity.
True
True or false: When developing cash flows for capital budgeting, it is easy to overlook important items.
True
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of more than one corporation.
Percentage returns are more convenient than dollar returns because they ____.
apply to any amount invested
From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage _____.
as low as possible
When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in _____.
asking what-if questions scenario analysis
To be considered good, projected cash flows should _____ actual cash flows.
be close to
OCF is calculated as net income plus depreciation using the _____ approach.
bottom-up
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 average return on the stock market can be used to ___.
compare stock returns with the returns on other securities
Historically, there is a(n) ______ relationship between risk and expected return in the stock market.
direct
Incremental cash flows come about as a(n) ________ consequence of taking a project under consideration.
direct
When developing cash flows for capital budgeting, it is _____ to overlook important items.
easy
The ______ rate of return is the difference between risky returns and risk-free returns.
excess Reason: The excess rate of return is the difference between risky returns and risk-free returns. The real rate is the nominal rate adjusted for inflation.
Evans Corporation estimated that the cash flows last year from a particular project would be $40,000, but the actual cash flow turned out to be $37,500. Evans Corporation should _____.
not expect cash flow estimates to be exactly right every time
The degree to which a firm or project relies on fixed costs is called the leverage.
operating
If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be _____.
positive
Normally, the excess rate of return on risky assets is ___.
positive
The Sharpe ratio measures ___.
reward to risk
As a practical matter, it is easier to (decrease/increase) operating leverage than it is to (decrease/increase) it.
Blank 1: increase Blank 2: decrease
Based on the historical returns shown in the text, the average was 2.9 percent per year over the 94-year span depicted.
Blank 1: inflation or inflation rate
The variance of a portfolio (is/isn't) generally a simple combination of the variances of the assets in the portfolio.
Blank 1: isn't, is not, not, or isnt
The basic approach to evaluating cash flow and NPV estimates involves asking -if questions.
Blank 1: what
Which of the following is the correct equation for the degree of operating leverage?
DOL = 1 + FC/OCF
True or false: Systematic risk will impact all securities in every portfolio equally.
False
True or false: The process to calculate a portfolio's beta is opposite of the process to calculate a portfolio's expected return.
False
Which of the following are reasons why NPV is considered a superior capital budgeting technique?
NPV considers all the cash flows. NPV considers time value of money.
Mona Corporation has a variance of returns of 343, while Scott Corporation has a variance of returns of 898. Which company's actual returns vary more from their mean return?
Scott Corporation
Which approach to estimating the operating cash flows uses the following equation? OCF = (Sales − Costs) × (1 − Tax rate) + Depreciation × Tax rate
Tax shield approach
The calculation of a portfolio beta is similar to the calculation of _____.
a portfolio's expected return
The dividend yield for a 1-year period is equal to the annual dividend amount divided by the ______.
beginning stock price
In an efficient market, firms should expect to receive ______ value for securities they sell.
fair
In terms of investments, the greater the potential risk, the (lower/greater) should be the expected return.
greater
The second lesson from studying capital market history is that risk is _____.
handsomely rewarded
A firm with higher operating leverage will have ______ fixed costs relative to a firm with low operating leverage.
high
A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are ______.
inaccurate
An increase in depreciation expense will ____ cash flows from operations.
increase
If the tax rate increases, the value of the depreciation tax shield will ______.
increase
For all practical purposes, it is easier to _____.
increase operating leverage than to decrease it
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 ______.
initial stock price
If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____.
is highly risky
Historically, the real return on Treasury bills has been _____.
quite low Reason: Historically, the real return on Treasury bills has been quite low, averaging 0.5 percent per year.
The first step in estimating cash flow is to determine the _________ cash flows.
relevant
West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately West Corporation lost money on the project. This may have been avoided had they assessed the ______ of the cash flow estimates.
reliability
The excess return on a risky asset is the difference between the risky return and the ____ rate.
risk-free
The standard deviation is ___.
the square root of the variance
The risk that affects a single asset or a small group of assets is ______ risk.
unsystematic
The square of the standard deviation is equal to the ____.
variance
The basic approach to evaluating cash flow and NPV estimates involves asking _____.
what-if questions
The weighted average of the standard deviations of the assets in Portfolio C is 12.9%. Which of the following are possible values for the standard deviation of the portfolio?
10.9% 12.9%
Based on average historical returns shown in the text, small-company stocks increased in value by _____ percent in a typical year.
16%
A firm faces many risks. Which of the following are examples of unsystematic risks faced by a firm?
A hostile takeover attempt by a competitor The death of the CEO
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
A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?
An increase in the Federal funds rate An increase in the corporate tax rate
True or false: The smaller the variance or standard deviation is, the more spread out the returns will be.
False
Place the steps in the computation of variance in the correct order from the first step to the last step.
1. Calculate the expected return 2. Determine the squared deviation from the expected return 3. Multiply each squared deviation by its probability 4. The result is the variance
What is a sunk cost?
A cost incurred in the past that is irrelevant to the capital investment decision process.
The step is to determine whether cash flows are relevant.
First
Which of the following are examples of systematic risk?
Future rates of inflation Regulatory changes in tax rates
What is a risk premium?
It is additional compensation for taking risk, over and above the risk-free rate.
What is the definition of expected return?
It is the return that an investor expects to earn on a risky asset in the future.
Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $1,000,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of $_____ as the base case.
1,000,000 Reason: The NPV of the scenario originally estimated is usually used as the base case.
The tax saving that results from the depreciation deduction is called the depreciation tax
Blank 1: shield
The first step to calculate the variances of the returns on two stocks is to determine the deviations from the expected return.
Blank 1: squared or square
The risk principle argues that the market does not reward unnecessary risk that is taken on by the investor.
Blank 1: systematic
Using the top-down approach, OCF is calculated by subtracting costs and from sales.
Blank 1: taxes or tax
The is the squared standard deviation.
Blank 1: variance or variation
The second lesson from capital market history is that there is a direct link between and reward.
Blank 1: risk
The portfolio weight is _____.
the percentage of the total value that is invested in an asset