FIN 310 Exam 2
Which one of the following types of securities has no priority in a bankruptcy proceeding? Convertible bond Senior debt Common stock Preferred stock Straight bond
Common Stock
Which one of the following generally pays a fixed dividend, receives first priority in dividend payment, and maintains the right to a dividend payment, even if that payment is deferred? Cumulative common Noncumulative common Noncumulative preferred Cumulative preferred Senior common
Cumulative Preferred
The managers of H.R Construction are considering remodeling plans for an old building the firm currently owns. The building was purchased 8 years ago for $689,000. Over the past 8 years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $898,000. The firm is considering remodeling the building into a conference centre and sandwich bar at an estimated cost of $1.7 million. The estimated present value of the future income from this centre is $2.9 million. Which one of the following defines the opportunity cost of the remodeling project? -Initial cost of the building -Cost of the remodeling -Current market value of the building -Initial cost of the building plus the remodeling costs -Current market value of the building plus the remodeling costs
Current market value of the building.
An agent who buys and sells securities from inventory is called a: floor trader. dealer. commission broker. broker. floor broker.
Dealer
Which one of the following defines the internal rate of return for a project? -Discount rate that creates a zero cash flow from assets -Discount rate which results in a zero net present value for the project -Discount rate which results in a net present value equal to the project's initial cost -Rate of return required by the project's investors -The project's current market rate of return
Discount rate which results in a zero net present values for the project.
Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk? -Systematic -Unsystematic -Diversification -Security market line -Capital asset pricing model
Diversification
Which one of the following terms is most commonly used to describe the cash flows of a new project that are simply an offset of reduced cash flows for a current project? -Opportunity cost -Sunk cost -Erosion -Replicated flows -Pirated flows
Erosion
The security market line is a linear function which is graphed by plotting data points based on the relationship between which two of the following variables? -Risk-free rate and beta -Market rate of return and beta -Market rate of return and the risk-free rate -Risk-free rate and the market rate of return -Expected return and beta
Expected return and beta
Which one of the following is defined as the average compound return earned per year over a multiyear period? -Geometric average return -Variance of returns -Standard deviation of returns -Arithmetic average return -Normal distribution of returns
Geometric average return.
The Blackwell Group is unable to obtain financing for any new projects under any circumstances. Which term best applies to this situation? -Contingency planning -Soft rationing -Hard rationing -Sensitivity analysis -Scenario analysis
Hard rationing.
Scenario analysis: -determines the impact a $1 change in sales has on the internal rate of return. -determines which variable has the greatest impact on a project's net present value. -helps determine the reasonable range of expectations for a project's anticipated outcome. -evaluates a project's net present value while sensitivity analysis evaluates a project's internal rate of return. -determines the absolute worst and absolute best outcome that could ever occur.
Helps determine the reasonable range of expectations for a project's anticipated outcome.
Sensitivity analysis: -looks at the most reasonably optimistic and pessimistic results for a project. -helps identify the variable within a project that presents the greatest forecasting risk. -is used for projects that cannot be analyzed by scenario analysis because the cash flows are unconventional. -is generally conducted prior to scenario analysis just to determine if the range of potential outcomes is acceptable. -illustrates how an increase in operating cash flow caused by changing both the revenue and the costs simultaneously will change the net present value for a project.
Helps identify the variable within a project that presents the greatest forecasting risk.
All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate -I only -I and III only -I and IV only -II and III only -II and IV only
I and IV only
Which of the following have the potential to increase the net present value of a proposed investment? I. ability to immediately shut down a project should the project become unprofitable II. ability to wait until the economy improves before making the investment III. option to place the investment on hold until a more favorable discount rate becomes available IV. option to increase production beyond that initially projected -I only -I and IV only -II and III only -I, II, and IV only -I, II, III, and IV
I, II, III, and IV
Which of the following should be included in the analysis of a proposed investment? I. erosion effects II. opportunity costs III. sunk costs IV. side effects -I only -II only -I and IV only -I, II, and IV only -I, II, III, and IV
I, II, and IV only
Based on the capital asset pricing model, investors are compensated based on which of the following? I. market risk premium II. portfolio standard deviation III. portfolio beta IV. risk-free rate -I and III only -II and IV only -I, II, and III only -I, III, and IV only -I, II, III, and IV
I, III, and IV only
Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate -II only -I and II only -I and III only -II and IV only -I, II, III, and IV
II and IV only
Which one of the following is an example of systematic risk? -Major layoff by a regional manufacturer of power boats -Increase in consumption created by a reduction in personal tax rates -Surprise firing of a firm's chief financial officer -Closure of a major retail chain of stores -Product recall by one manufacturer
Increase in consumption created by a reduction in personal tax rates.
A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? -Increasing the firm's tax rate -Issuing new bonds at par -Redeeming shares of common stock -Increasing the firm's beta -Increasing the debt-equity ratio
Increasing the firm's beta.
Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as which one of the following? -Eroded cash flows -Deviated projections -Incremental cash flows -Directly impacted flows -Assumed flows
Incremental cash flows.
The profitability index reflects the value created per dollar: -invested. -of sales. -of net income. -of taxable income. -of shareholders' equity.
Invested
The cost of preferred stock: -increases when a firm's tax rate decreases. -is constant over time. -is unaffected by changes in the market price. -is equal to the stock's dividend yield. -increases as the price of the stock increases.
Is equal to the stock's dividend yield.
Inside quotes are defined as the: -bid and asked prices presented by NYSE specialists. -last bid and asked price offered prior to the market close. -lowest asked and highest bid offers. -daily opening bid and asked quotes. -last traded bid and asked prices.
Lowest asked and highest bid offers
The systematic risk principle states that the expected return on a risky asset depends only on which one of the following? -Unique risk -Diversifiable risk -Asset-specific risk -Market risk -Unsystematic risk
Market risk
Which one of the following is the slope of the security market line? -Risk-free rate -Market risk premium -Beta coefficient -Risk premium on an individual asset -Market rate of return
Market risk premium
Ignoring the option to wait: -may overestimate the internal rate of return on a project. -may underestimate the net present value of a project. -ignores the ability of a manager to increase output after a project has been implemented. -is the same as ignoring all strategic options. -ignores the value of discontinuing a project early.
May underestimate the net present value of a project.
Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of eight years. -New tires that will be purchased this winter -Costs of repairs needed so the truck can pass inspection next month -Money spent last month repairing a damaged front fender -Engine tune-up that is scheduled for this afternoon -Cost for a truck driver for the remainder of the truck's useful life
Money spent last month repairing a damaged front fender.
A specialist is a(n): -employee who executes orders to buy and sell for clients of his or her brokerage firm. -individual who trades on the floor of an exchange for his or her personal account. -NYSE member who functions as a dealer for a limited number of securities. -broker who buys and sells securities from a market maker. -trader who only deals with primary offerings.
NYSE member who functions as a dealer for a limited number of securities
Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? -Payback -Profitability index -Accounting rate of return -Internal rate of return -Net present value
Net present value.
Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio: -for the portfolio must equal 1.0. -for the portfolio must be less than the market risk premium. -for each security must equal zero. -of each security is equal to the risk-free rate. -of each security must equal the slope of the security market line.
Of each security must equal the slope of the security market line.
If the financial markets are semi-strong form efficient, then: -only the most talented analysts can determine the true value of a security. -only individuals with private information have a marketplace advantage. -technical analysis provides the best tool to use to gain a marketplace advantage. -no one individual has an advantage in the marketplace. -every security offers the same rate of return.
Only individuals with private information have a marketplace advantage.
Which one of the following terms refers to the best option that was foregone when a particular investment is selected? -Side effect -Erosion -Sunk cost -Opportunity cost -Marginal cost
Opportunity cost.
Turner Industries started a new project three months ago. Sales arising from this project are exceeding all expectations. Given this, which one of the following is management most apt to implement? -Option to wait -Soft rationing -Strategic option -Option to abandon -Option to expand
Option to expand
Which one of the following indicates that a project is expected to create value for its owners? -Profitability index less than 1.0 -Payback period greater than the requirement -Positive net present value -Positive average accounting rate of return -Internal rate of return that is less than the requirement
Positive net present value.
Newly issued securities are sold to investors in which one of the following markets? -Proxy -Stated value -Inside -Secondary -Primary
Primary
Which one of the following best describes an arithmetic average return? -Total return divided by N - 1, where N equals the number of individual returns -Average compound return earned per year over a multiyear period -Total compound return divided by the number of individual returns -Return earned in an average year over a multiyear period -Positive square root of the average compound return
Return earned in an average year over a multiyear period.
Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? -Amount of debt used to finance the project -Use, or lack thereof, of preferred stock to finance the project -Mix of funds used to finance the project -Risk level of the project -Length of the project's life
Risk level of the project.
Which one of the following describes systemic risk? -Risk that affects a large number of assets -An individual security's total risk -Diversifiable risk -Asset specific risk -Risk unique to a firm's management
Risk that affects a large number of assets
Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value. What type of analysis is Mark conducting? -Sensitivity analysis -Erosion planning -Scenario analysis -Cost-benefit analysis -Opportunity cost analysis
Sensitivity analysis.
Which one of the following categories has the widest frequency distribution of returns for the period 1926-2008? -Small-company stocks -U.S. Treasury bills -Long-term government bonds -Inflation -Large-company stock
Small company stocks.
Which one of the following is the most apt to have the largest risk premium in the future based on the historical record for 1926-2008? -U.S. Treasury bills -Large-company stocks -Long-term government debt -Small-company stocks -Long-term corporate debt
Small-company stocks.
Marcos Enterprises has three separate divisions. The firm allocates each division $1.5 million per year for capital purchases. Which one of the following terms applies to this allocation process? -Soft rationing -Hard rationing -Opportunity cost -Sunk cost -Strategic planning
Soft rationing
If the financial markets are efficient then: -stock prices should remain constant. -stock prices should increase or decrease slowly as new events are analyzed and the information is absorbed by the markets. -an increase in the value of one security should be offset by a decrease in the value of another security. -stock prices will only change when an event actually occurs, not at the time the event is anticipated. -stock prices should only respond to unexpected news and events.
Stock prices should only respond to unexpected news and events.
Which one of the following refers to the option to expand into related businesses in the future? -Strategic option -Contingency option -Soft rationing -Hard rationing -Capital rationing option
Strategic option
A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost? -Fixed -Forgotten -Variable -Opportunity -Sunk
Sunk
The risk premium for an individual security is based on which one of the following types of risk? -Total -Surprise -Diversifiable -Systematic -Unsystematic
Systematic
Which one of the following statements is correct? -The risk-free rate of return has a risk premium of 1.0. -The reward for bearing risk is called the standard deviation. -Risks and expected return are inversely related. -The higher the expected rate of return, the wider the distribution of returns. -Risk premiums are inversely related to the standard deviation of returns.
The higher the expected rate of return, the wider the distribution of returns.
The beta of a risky portfolio (assuming no borrowing or shortselling) cannot be less than _____ nor greater than _____. -0; 1 -1; the market beta -the lowest individual beta in the portfolio; market beta -the market beta; the highest individual beta in the portfolio -the lowest individual beta in the portfolio; the highest individual beta in the portfolio
The lowest individual beta in the portfolio; the highest individual beta in the portfolio.
An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true? -The internal rate of return exceeds the required rate of return. -The investment never pays back. -The net present value is equal to zero. -The average accounting return is 1.0. -The net present value is greater than 1.0.
The net present value is equal to zero.
Which one of the following statements is correct? -The internal rate of return is the most reliable method of analysis for any type of investment decision. -The payback method is biased towards short-term projects. -The modified internal rate of return is most useful when projects are mutually exclusive. -The average accounting return is the most difficult method of analysis to compute. -The net present value method is only applicable if a project has conventional cash flows.
The payback method is biased towards short-term projects.
New Labs just announced that it has received a patent for a product that will eliminate all flu viruses. This news is totally unexpected and viewed as a major medical advancement. Which one of the following reactions to this announcement indicates the market for New Labs stock is efficient? -The price of New Labs stock remains unchanged. -The price of New Labs stock increases rapidly and then settles back to its pre-announcement level. -The price of New Labs stock increases rapidly to a higher price and then remains at that price. -All stocks quickly increase in value and then all but New Labs stock fall back to their original values. -The value of all stocks suddenly increase and then level off at their higher values.
The price of New Labs stock increases rapidly to a higher price and the remains at that price.
Over the period of 1926-2008: -the risk premium on large-company stocks was greater than the risk premium on small- company stocks. -U.S. Treasury bills had a risk premium that was just slightly over 2 percent. -the risk premium on long-term government bonds was zero percent. -the risk premium on stocks exceeded the risk premium on bonds. -U. S. Treasury bills had a negative risk premium.
The risk premium on stocks exceeded the risk premium on bonds.
Which one of the following best exemplifies unsystematic risk? -Unexpected economic collapse -Unexpected increase in interest rates -Unexpected increase in the variable costs for a firm -Sudden decrease in inflation -Expected increase in tax rates
Unexpected increase in the variable costs for a firm.
Portfolio diversification eliminates which one of the following? -Total investment risk -Portfolio risk premium -Market risk -Unsystematic risk -Reward for bearing risk
Unsystematic risk
Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities? -Cost of equity -Internal rate of return -Aftertax cost of debt -Weighted average cost of capital -Debt-equity ratio
Weighted average cost of capital.
Which one of the following is the pre-tax cost of debt? -Average coupon rate on the firm's outstanding bonds -Coupon rate on the firm's latest bond issue -Weighted average yield-to-maturity on the firm's outstanding debt -Average current yield on the firm's outstanding debt -Annual interest divided by the market price per bond for the latest bond issue
Weighted average yield-to-maturity on the firm's outstanding debt.
Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security? -Security beta multiplied by the market rate of return -Market risk premium -Security beta multiplied by the market risk premium -Risk-free rate of return -Zero
Zero
Standard deviation measures _____ risk while beta measures _____ risk. -systematic; unsystematic -unsystematic; systematic -total; unsystematic -total; systematic -asset-specific; market
total; systematic
Which one of the following statements is correct, all else held constant? -Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred. -A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. -The aftertax cost of debt increases when the market price of a bond increases. -If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. -WACC is only applicable to firms that issue both common and preferred stock.
A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project? -Boone Brothers' cost of capital -Ace Builders' cost of capital -Average of Boone Brothers' and Ace Builders' cost of capital -Lower of Boone Brothers' or Ace Builders' cost of capital -Higher of Boone Brothers' or Ace Builders' cost of capital
Ace Builder's cost of capital.
Semi-strong form market efficiency states that the value of a security is based on: -all public and private information. -historical information only. -all publicly available information. -all publicly available information plus any data that can be gathered from insider trading. -random information with no clear distinction as to the source of that information.
All publicly available information.
Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably: -require the highest rate of return from division X since it has been in existence the longest. -assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions. -use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm. -use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm. -allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.
Assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm: -automatically gives preferential treatment in the allocation of funds to its riskiest division. -encourages the division managers to only recommend their most conservative projects. -maintains the current risk level and capital structure of the firm. -automatically maximizes the total value created for its shareholders. -allocates capital funds evenly amongst its divisions.
Automatically gives preferential treatment in the allocation of funds to its riskiest division.
An efficient capital market is best defined as a market in which security prices reflect which one of the following? -Current inflation -A risk premium -Available information -The historical arithmetic rate of return -The historical geometric rate of return
Available information
Which one of the following methods of analysis ignores cash flows? -Profitability index -Net present value -Average accounting return -Modified internal rate of return -Internal rate of return
Average accounting return.
Which one of the following methods of analysis is most similar to computing the return on assets (ROA)? -Internal rate of return -Profitability index -Average accounting return -Net present value -Payback
Average accounting return.
A broker is an agent who: -trades on the floor of an exchange for himself or herself. -buys and sells from inventory. -offers new securities for sale to dealers only. -who is ready to buy or sell at any time. -brings buyers and sellers together.
Brings buyers and sellers together
