FIN 3403 Exam 3 Conceptual

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

fixed costs:

are constant over the short-run regardless of the quantity of output produced

the return earned in an average year over a multi-year period is called the _______ average return

arithmetic

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

which one of the following statements correctly applies to the period 1926-2010?

US treasury bills had a positive average real rate of return

which one of the following would make a project unacceptable?

an equivalent annual cost that exceeds that of an alternative project

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

assume that you invest in a portfolio of large-company stocks. further assume that the portfolio will earn a rate of return similar to the average return on large-company stocks for the period 1926-2010. what rate of return should you expect to earn?

between 10 and 12.5 percent

what was the highest annual rate of inflation during the period 1926-2010?

between 10 and 15 percent

what was the average rate of inflation over the period of 1926-2010?

between 3.0 and 3.5 percent

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 a cash inflow or a cash outflow at time zero of a project

which one of the following is the relationship between the percentage change in operating cash flow and the percentage change in quantity sold?

degree of operating leverage

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?

depreciating expense

scenario analysis is defined as the:

determination of changes in NPV estimates when what-if questions are posed

given the following, which feature identified the most desirable level of output for a project?

discounted payback period equal to the project's life

assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. which one of the following terms best defines the market?

efficient capital market

ted is analyzing a project using simulation. his focus is limited to the short-term. to ease the simulation process, he is combining expenses into various categories. which one of the following should he include in the fixed cost category?

equipment insurance

dan is comparing three machines to determine which one to purchase. the machines sell for differing prices, have differing operating costs, differing 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

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

equivalent annual cost

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% in a good economy and a 3% in a poor economy. given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5% next year. which one of the following terms applies to this 6.5%?

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

which one of the following is defined as the sales level that corresponds to a zero NPV?

financial break-even

which one of the following represents the level of output where a project produces a rate of return just equal to its requirement?

financial break-even

you would like to know the minimum level of sales that is needed for a project to be accepted based on its net present value. to determine that sales level you should compute the:

financial break-even point

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

financial statements showing projected values for future time periods

operating leverage is the degree of dependence a firm places on its:

fixed costs

the average compound return earned per year over a multi-year 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 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 one of the following characteristics best describes a project that has a low degree of operating leverage?

high variable costs relative to the fixed costs

kelley 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

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

ignores non cash expenses

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 advocates that project analysis should be based solely on which one 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 does not accept the project is referred to as the project's:

incremental cash flows

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

according to theory, studying historical stock price movements to identify misplaced stocks:

is ineffective even when the market is only weak form efficient

webster iron works started a new project last year. as it turns out, the project has been operating at its accounting break-even level of output and is now expected to continue at that level over its lifetime. given this, you know that the project:

is operating at a higher level than if it were operating at its cash break-even level

the market rate of return is 11% and the risk-free rate of return is 3%. lexant stock has 3% less systematic risk than the market and has an actual return of 12%. this stock:

is underpriced

the historical record for the period 1926-2010 supports which one of the following statements?

it is possible for small-company stocks to more than double in value in any one given year

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

the base case values used in scenario analysis are the ones considered the most:

likely to occur

which one of the following statements is correct based on the historical record for the period 1926-2010?

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

you are considering a project that you believe is quite risky. to reduce any potentially harmful results from accepting this project, you could:

lower the degree of operating leverage

you are considering the purchase of a new machine. your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. whichever machine is purchase will be replaced at the end of its useful life. you should select the machine which has the:

lowest equivalent annual cost

individuals who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient

steve, the sales manager for tl products, wants to sponsor a one-week "customer appreciate sale" where the firm offers to sell additional units of a product at the lowest price possible without negatively affecting the firm's profits. which one of the following represents the price that should be charged for the additional units during this sale?

marginal cost

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 systemic risk is measured by _____

standard deviation; beta

the US 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

which one of the following will best reduce the risk of a project by lowering the degree of operating leverage?

subcontracting portions of the project rather than purchasing new equipment to do all the work in-house

the market risk premium is computed by:

subtracting the risk-free rate of return from the market rate or 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 is a risk that applies to most securities?

systematic

the ______ tells us that the expected return on a risky asset's nondiversifiable risk

systematic risk principle

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

a project has a payback period that exactly equals the project's life. the project is operating at:

the accounting break-even point

which one of the following statements concerning US treasury bills is correct for the period 1926-2010?

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 average 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 statement?

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 come at the expense of a firm's existing cash flows

which one of the following statements is correct?

the greater the volatility of returns, the greater the risk premium

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

the interest expense is equal to zero

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 reasonably be expected

efficient financial markets fluctuate continuously because:

the markets are continually reacting to new information

the bid price is:

the minimum price you should charge if you want to earn a target return on investment

a project has a projected IRR of negative 100%. which one of the following statements must also be true concerning this project?

the net present value of the project is negative and equal to the initial investment

dexter smith & co. is replacing a machine simply because it has worn out. the new machine will not affect either sales or operating costs an will not have any salvage value at the end of its 5-year life. the firm has a 34% 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, at least in the first few years of its life

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

the risk-free rate

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

the slope 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 of a 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

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

unexpected returns can be either 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 about 20%. what type of risk does this news flash represent?

unsystematic

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

unsystematic risk

which one of the following statements concerning variable costs is correct?

variable costs per unit are inversely related to the contribution margin per unit

variable costs can be defined as the costs that:

vary directly with sales

sensitivity analysis is based on:

varying a single variable and measuring the resulting change in the NPV of a project

standard deviation is a measure of which one of the following?

volatility

if you excel in analyzing the future outlook of firms, you would prefer the financial markets be _____ form efficient so that you can have an advantage in the marketplace

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

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 machine lives, and will be replaced once they are worn out

simulation analysis is based on assigning a ______ an analyzing the results.

wide range of values to multiple variables simultaneously

a company the utilizes the MARCS system of depreciation:

will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life

when you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under 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

the president of global wholesalers would like to offer special sale prices to the firm's best customers under the following terms: 1. the prices will apply only to units purchased in excess of the quantity normally purchased by a customer 2. the units purchased must be paid for in cash at the time of sale 3. the total quantity sold under these terms cannot exceed the excess capacity of the firm 4. the net profit of the firm should not be affected 5. the prices will be in effect for one week only given these conditions, the special sale price should be set equal to the:

marginal cost of all variable inputs

the change in variable costs that occurs when production is increased by one unit is referred to as the:

marginal costs

the change in revenue the occurs when one more unit of output is sold is referred to as:

marginal revenue

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 being the risk of an individual security depends upon the:

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

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

market value of the investment in each stock

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

by definition, which one of the following must equal zero at the accounting break-even point?

net income

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 defined by its mean and its standard deviation?

normal distribution

by definition, which one of the following must equal zero at the cash break-even point?

operating cash flow

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

opportunity cost

which one of the following statements is correct?

over time, the average unexpected return will be zero

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

overestimate; underestimate

susie 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 susie's investments?

portfolio

steve has invested in twelve different stocks that have a combined value today of $121,300. 15% of that total is invested in wise man foods. the 15% is a measure of which one of the following?

portfolio weight

which one of the following time periods is associated with high rates of inflation?

1978-1981

the average annual return on small-company stocks was about _______ percent greater than the average annual return on large-company stocks over the period 1926-2010?

5

the primary purpose of plume's formula is to:

project future rates of return

which one of the following is 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

last year, t-bills returned 2% while your investment in large-company stocks earned an average of 5%. which one of the following terms refers to the difference between these two rates of return?

risk premium

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

risk-free rate

three years ago, knox glass purchased a machine for a 3-year project. the machine is being depreciated straight-line to zero over a 5-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

the contribution margin per unit is equal to the:

sales price per unit minus the variable cost per unit

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

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

you are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. the 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.

semistrong

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 most critical to the success of a particular project?

sensitivity

an analysis which combines scenario analysis with sensitivity is called ______ analysis.

simulation

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

simulation

which one of the following categories of securities has the highest average return (and risk premium) for the period 1926-2010?

small company stocks

which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2010? rank from highest to lowest.

small company stocks, long-term corporate bonds, intermediate-term government bonds

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

smallest twenty percent of the firms listed on the NYSE

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

soft rationing

at the accounting break-even point, the:

IRR is zero

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, respectively. for the firm as a whole, the management of uptown promotions has limited spending to $10 million for new projects next year. this is an example of:

soft rationing

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

$1,200 paid to repair a machine last year

morris motors just purchased some MARCS 5-yr property at a cost of $216,000. which one of the following will correctly give you the book value of this equipment at the end of year 2?

$216,000 * (1 -.20 - .32)

keyser petroleum just purchased some equipment at a cost food $67,000. what is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5-year property for MARCS?

$67,000 * .32

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

stock with a beta of 1.38

the degree of operating leverage is equal to:

1 + FC/OCF

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

according to jeremy siegel, the real return on stocks over the long-term has averaged about:

6.7 percent

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

ACRS

which one of the following categories of securities had the lowest average risk premium for the period 1926-2010?

US treasury bills

which one of the following was the least volatile over the period of 1926-2010?

US treasury bills

the bid price always assumes which one of the following?

the net present value of the project is zero

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

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?

NI + D

which one of the following statements is a correct reflection of the US markets for the period 1926-2010?

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

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 statements is correct concerning bid price?

a firm can submit a bid that is higher than 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

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

a firm's sales decrease

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

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

accuracy of the projected cash flows

the depreciate tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense

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

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

valerie just completed analyzing a project. her analysis indicates that the project will have a 6-year life and require an initial cash outlay of $320,000. annual sales are estimated at $589,000 and the tax rate is 34%. the net present value is a negative $320,000. based on this analysis, the project is expected to operate at the:

cash break-even point

when the operating cash flow of a project is equal to zero the project is operating at the:

cash break-even point

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

consumer spending on entertainment decreased nationally

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

which one of the following is a project cash inflow? ignore any tax effects.

decrease in accounts receivable

the net book value of equipment will:

decrease slower under straight-line depreciation that under MACRS

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

sensitivity analysis determines the:

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

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 .82 and stock B has a beta of 1.29. this information implies that:

either stock A is overpriced 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

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

equivalent annual cost

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

identifying the potential range of reasonable outcomes

inside information has the least value when financial markets are:

strong form efficient