Finance 304 Final conceptual study guide (ch. 12-16)

d. Personal contacts

1. Which one of the following is probably the most successful means of finding venture capital? a. Internet searches b. Tombstone ads c. Newspaper advertisements d. Personal contacts e. Personal letters to venture capital firms

b. Maximizes the value of the firm

A firm should select the capital structure that: a. Produces the highest cost of capital b. Maximizes the value of the firm c. Minimizes taxes d. Is fully unlevered e. Equates the value of debt with the value of equity

b. Cost of equity

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? a. Dividend yield b. Cost of equity c. Capital gains yield d. Cost of capital e. Income return

d. Rights offer

Alberto currently owns 2,500 shares of Southern Tools. He has just been notified that the firm is issuing additional shares and he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called? a. Best efforts offer b. Firm commitment offer c. General cash offer d. Rights offer e. Priority offer

e. Provides better returns to issuing firms

All of the following are supporting arguments in favor of IPO underpricing except which one? a. Helps prevent the "winner's curse" b. Rewards institutions investors who share their market value opinions c. Reduces potential lawsuits against underwriters d. Diminishes underwriting risk e. Provides better returns to issuing firms

c. Less than

As long as the inflation rate is positive, the real rate of return on a security will be ___ the nominal rate of return. a. Greater than b. Equal to c. Less than d. Greater than or equal to e. Unrelated to

c. II and IV

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? i. Asset's standard deviation ii. Asset's beta iii. Risk free rate of return iv. Market risk premium b. I and III c. II and IV d. III and IV e. I, III, and IV f. I, II, and IV

c. A standby fee

BK & Co. offered 15,000 shares in a rights offer. T.L. Moore & Co. was the underwriter that by prior agreement purchased the 1,315 unsold shares. For its participation in this rights offer, T.L. Moore & Co. is most likely entitled to: a. Gross margin b. The optional spread c. A standby fee d. The subscription price e. An oversubscription fee

b. Percentage ownership dilution

Before a seasoned stock offering, you owned 7,500 shares of a firm that had 500,000 shares outstanding. After the seasoned offering, you still owned 7,500 shares but the number of shares outstanding rose to 625,000. Which one of the following terms best describes this situation? a. Overallotment b. Percentage ownership dilution c. Green Shoe allocation d. Red herring allotment e. Abnormal event

c. The firm's cost of equity is unaffected by a change in the firm's tax rate

Black River Tours has a capital structure of 55% common stock, 5% preferred stock, and 40% debt. The firm has a 30% dividend payout ratio, a beta of 1.21, and a tax rate of 34%. Given this, which one of the following statements is correct? a. The after tax cost of debt will be greater than the current yield to maturity on the firm's outstanding bonds b. The firm's cost of preferred is most likely less than the firm's actual cost of debt c. The firm's cost of equity is unaffected by a change in the firm's tax rate d. The cost of equity can only be estimated using the capital asset pricing model. e. The firm's weighted average cost of capital will remain constant as long as the firm's capital structure remains constant

b. Underutilize debt

Corporations in the US tend to: a. Minimize taxes b. Underutilize debt c. Rely less on equity financing than they should d. Have relatively similar debt-equity ratios across industry lines e. Rely more heavily on debt than on equity as the major source of financing

b. Oversubscription privilege

Franklin Minerals recently had a rights offering of 1,000 shares at an offer price of $10 a share. Isabelle is a shareholder who exercised her rights option by buying all of the rights to which she was entitled based on the number of shares she owns. Currently, there are six shareholders who have opted not to participate in the rights offering. Isabelle would like to purchase the unsubscribed shares. Which one of the following will allow her to do so? a. Standby provision b. Oversubscription privilege c. Open offer privilege d. New issues provision e. Overallotment provision

d. By using the capital asset pricing model

High Adventure is considering a new project that is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of .55 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? a. By adding the market risk premium to the after tax cost of debt b. By multiplying the market risk premium by 1.55 c. By using the dividend growth model d. By using the capital asset pricing model e. By averaging the costs based on the dividend growth model and the capital asset pricing model

d. Are more apt to receive shares if the IPO is under allocated

Individual investors might avoid requesting 100 shares in an upcoming IPO because they: a. Do not want to be bothered with submitting their bid to the SEC for approval b. Do not want to abide by the quiet period requirement c. Are prevented from entering orders for less than 1,000 shares d. Are more apt to receive shares if the IPO is under allocated e. Would have to pay a premium based on their small order size

b. Make the markets increasingly more efficient

Individual investors who continually monitor the financial markets seeking mispriced securities: a. Earn excess profits on all of their investments b. Make the markets increasingly more efficient c. Are never able to find a security that is temporarily mispriced d. Are overwhelmingly successful in earning abnormal profits e. Are always quite successful using only historical price information as their basis of evaluation

a. Regulation A

M&C Merchants is offering $2.5 million of new securities to the general public. Which SEC regulation governs this offering? a. Regulation A b. Regulation C c. Regulation G d. Regulation Q e. Regulation R

c. The debt-equity ratio of a firm is completely irrelevant

M&M Proposition I with no tax supports the argument that: a. Business risk has no effect on the return on assets b. The cost of equity rises as leverage rises c. The debt-equity ratio of a firm is completely irrelevant d. Business risk is irrelevant e. Homemade leverage is irrelevant

c. Dilution

Roy owns 200 shares of R.T.F., Inc. He has opted not to participate in the current rights offering by this firm. a. An oversubscription cost b. Underpricing c. Dilution d. The green shoe provision e. A locked-in period

b. Portfolio

Suzie 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 Suzie's investments? a. Index b. Portfolio c. Collection d. Grouping e. Risk-free

b. The total cash flow of the firm

The basic lesson of M&M theory is that the value of a firm is dependent upon: a. The firm's capital structure b. The total cash flow of the firm c. Minimizing the marketed claims d. The amount of marketed claims to that firm e. Size of the stockholders' claims

d. Weighted average of the returns for each economic state

The expected return on a stock given various states of the economy is equal to the: a. Highest expected return given any economic state b. Arithmetic average of the returns for each economic state c. Summation of the individual expected rates of return d. Weighted average of the returns for each economic state e. Return for the economic state with the highest probability of occurrence

b. Rate of return a firm must earn on its existing assets to maintain the current value of its stock

The weighted average cost of capital for a firm with debt is the: a. Discount rate that the firm should apply to all of the projects is undertakes b. Rate of return a firm must earn on its existing assets to maintain the current value of its stock c. Coupon rate the firm should expect to pay on its next bond issue d. Minimum discount rate the firm should require on any new project e. Rate of return shareholders should expect to earn on their investment in this firm

d. Standard deviation; beta

Total risk is measured by ____ and systematic risk is measured by ____. a. Beta; alpha b. Beta; standard deviation c. Alpha; beta d. Standard deviation; beta e. Standard deviation; variance

c. 180 days

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, how long after a firm files for bankruptcy protection do creditors have to wait before submitting their own reorganization plan to the court? a. 60 days b. 45 days c. 180 days d. 12 months e. 18 months

a. Interest tax shield

Westover Mills reduced its taxes last year by $680 by increasing its interest expense by $2,000. Which one of the following terms is used to describe this tax savings? a. Interest tax shield b. Interest credit c. Homemade leverage shield d. Current tax yield e. Tax-loss interest

c. General cash offer

What is an issue of securities that is offered for sale to the general public on a direct cash basis called? a. Best efforts underwriting b. Firm commitment underwriting c. General cash offer d. Rights offer e. Herring offer

e. A group of underwriters sharing the risk of selling a new issue of securities

What is the definition of a syndicate? a. A venture capitalist b. A group of attorneys providing services for an IPO c. Block of investors who control a firm d. A bank that loans funds to finance the startup of a new firm e. A group of underwriters sharing the risk of selling a new issue of securities

e. Between 15 and 20 percent

What was the highest annual rate of inflation during the period 1926-2013? a. Between 0 and 3 percent b. Between 3 and 5 percent c. Between 5 and 10 percent d. Between 10 and 15 percent e. Between 15 and 20 percent

b. Pure play

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the ____ approach. a. Subjective risk b. Pure play c. Divisional cost of capital d. Capital adjustment e. Security market line

c. Expected rate of return

Which one of the following is most directly affected by the level of systematic risk in a security? a. Variance of the returns b. Standard deviation of the returns c. Expected rate of return d. Risk free rate e. Market risk premium

a. Beta

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? a. Beta b. Reward-to-risk ratio c. Risk ratio d. Standard deviation e. Price-earnings ratio

b. Exit strategy is a key consideration when selecting a venture capitalist

Which one of the following statements concerning venture capitalists is correct? a. Venture capitalists assume management responsibility for the firms they finance b. Exit strategy is a key consideration when selecting a venture capitalist c. Venture capitalists limit their services to providing money to start-up firms d. Most venture capitalists are long-term investors in a firm e. A venture capitalist normally invests in a new idea and finances that idea until the newly-formed firm can issue an IPO

b. All successful bidders pay the same price per share

With Dutch auction underwriting: a. Each winning bidder pays the minimum price offered by any bidder b. All successful bidders pay the same price per share c. All bidders receive at least a portion of the quantity for which they bid d. The selling firm receives the maximum possible price for each security sold e. The bidder for the largest quantity receives the first allocation of securities

e. Is highly dependent upon the firm's tax rate

1. The aftertax cost of debt: a. Varies inversely to changes in market interest rates b. Will generally exceed the cost of equity if the relevant tax rate is zero c. Will generally equal the cost of preferred if the tax rate is zero d. Is unaffected by changes in the market rate of interest e. Is highly dependent upon the firm's tax rate

b. Return on a risky security minus the risk-free rate

1. The excess return is computed as the: a. Return on a security minus the inflation rate b. Return on a risky security minus the risk-free rate c. Risk premium on a risky security minus the risk-free rate d. Risk free rate plus the inflation rate e. Risk free rate minus the inflation rate

b. I and III

1. Which of the following statements concerning risk are correct? i. Non diversifiable risk is measured by beta ii. The risk premium increases as diversifiable risk increases iii. Systematic risk is another name for non diversifiable risk iv. Diversifiable risks are market risks you cannot avoid b. I and III c. II and IV d. I and II e. III and IV f. I, II, and III

c. The systematic risk of a portfolio can be effectively lowered by adding Tbills to the portfolio

1. Which one of the following statements related to risk is correct? a. The beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio b. Every portfolio that contains 25 or more securities is free of unsystematic risk c. The systematic risk of a portfolio can be effectively lowered by adding Tbills to the portfolio d. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta e. Stocks that move in tandem with the overall market have zero betas

d. Unsystematic

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by 20 percent. What type of risk does this new flash best represent? a. Portfolio b. Non diversifiable c. Market d. Unsystematic e. Total

a. Investors in the IPO may consider suing the underwriters

If a firm commitment IPO overpriced then the: a. Investors in the IPO may consider suing the underwriters b. Green Shoe provision will probably be utilized c. Stock price will generally increase on the first day of trading d. Issuing firm is guaranteed to be successful in the long term e. Issuing firm receives less money than it probably should have

b. Value of the levered firm will exceed the value of the firm if it were unlevered

If a firm has the optimal amount of debt, then the: a. Direct financial distress costs must equal the present value of the interest tax shield b. Value of the levered firm will exceed the value of the firm if it were unlevered c. Value of the firm is minimized d. Value of the firm is equal to VL + TC ×D e. Debt-equity ratio is equal to 1

b. Lower the average risk level of the firm over time

If a firm uses its WACC as the discount rate for all of the projects it undertakes, then the firm will tend to do all of the following expect: a. Reject some positive net present value projects b. Lower the average risk level of the firm over time c. Increase the firm's overall level of risk over time d. Accept some negative net present value projects e. Favor high risk projects over low risk projects

e. Seed money

Lamar has been experimenting in his garage and now has a product he feels could be successfully marketed. A venture capitalist has offered to finance the development of this product until it reaches the manufacturing and marketing stage. Which type of financing is being offered? a. Syndicate b. Introduction c. Second-stage d. Mezzanine-level e. Seed money

b. Volatility

Standard deviation is a measure of which one of the following? a. Average rate of return b. Volatility c. Probability d. Risk premium e. Real returns

b. Beta

Systematic risk is measured by: a. The mean b. Beta c. The geometric average d. The standard deviation e. The arithmetic average

e. Which parties receive payment first in a bankruptcy proceeding

The absolute priority rule determines: a. When a firm must be declared officially bankrupt b. How a distressed firm is reorganized c. Which judge is assigned to a particular bankruptcy case d. How long a reorganized firm is allowed to remain under bankruptcy protection e. Which parties receive payment first in a bankruptcy proceeding

d. Geometric

The average compound return earned per year over a multiyear period is called the ____ average return. a. Arithmetic b. Standard c. Variant d. Geometric e. Real

b. The weighted average of the flotation costs associated with each form of financing

The flotation cost for a firm is computed as: a. The arithmetic average of the flotation costs of both debt and equity b. The weighted average of the flotation costs associated with each form of financing c. The geometric average of the flotation costs associated with each form of financing d. One-half of the flotation cost of debt plus one-half of the flotation cost of equity e. A weighted average based on the book values of the firm's debt and equity.

d. Small company stocks have lost as much as 50 percent and gained as much as 100 percent in a single year

The historical record for the period 1926-2013 supports which one of the following statements? a. When large company stocks have a negative return, they will have a negative return for at least two consecutive years. b. The return on US treasury bills exceeds the inflation rate by at leasat .5 percent each year c. There was only one year during the period when double digit inflation occurred d. Small company stocks have lost as much as 50 percent and gained as much as 100 percent in a single year e. The inflation rate was positive each year throughout the period

c. The net cost of debt to a firm is generally less than the cost of equity

The interest tax shield is a key reason why: a. The required rate of return on assets rises when debt is added to the capital structure b. The value of an unlevered firm is equal to the value of a levered firm c. The net cost of debt to a firm is generally less than the cost of equity d. The cost of debt is equal to the cost of equity for a levered firm e. Firms prefer equity financing over debt financing

e. Project future rates of return

The primary purpose of Blume's formula is to: a. Compute an accurate historical rate of return b. Determine a stock's true current value c. Consider compounding when estimating a rate of return d. Determine the actual real rate of return e. Project future rates of return

e. Can be less than the standard deviation of the least risky security in the portfolio

The standard deviation of a portfolio: a. Is a weighted average of the standard deviation of the individual securities held in the portfolio b. Can never be less than the average standard deviation of the most risky security in the portfolio c. Must be equal to or greater than the lowest standard deviation of any single security held in the portfolio d. Is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio e. Can be less than the standard deviation of the least risky security in the portfolio

c. Assigns discount rates to projects based on the discretion of the senior managers of a firm

The subjective approach to project analysis: a. Is used only when a firm has an all-equity capital structure b. Uses the WACC of Firm X as the basis for the discount rate for a project under consideration by Firm Y c. Assigns discount rates to projects based on the discretion of the senior managers of a firm d. Allows managers to randomly adjust the discount rate assigned to a project once the project's beta has been determined e. Applies a lower discount rate to projects that are financed totally with equity as comparted to those that are partially financed with debt.

e. Submit the required number of rights along with the subscription price

To purchase a share in a rights offering, an exiting shareholder generally just needs to: a. Pay the subscription amount in cash b. Submit the required form along with the required number of rights c. Pay the difference between the market price of the stock and the subscription price d. Submit the required number of rights along with a payment for the underwriting fee e. Submit the required number of rights along with the subscription price

e. Increase the initial project cost by dividing that cost by (1 - 0.068)

When a firm has flotation costs equal to 6.8% of the funding need, project analysts should: a. Increase the project's discount rate to offset these expenses by multiplying the firm's WACC by 1.068 b. Increase the project's discount rate to offset these expenses by dividing the firm's WACC by (1 - 0.068). c. Add 6.8% to the firm's WACC to determine the discount rate for the project d. Increase the initial project cost by multiplying that cost by 1.068 e. Increase the initial project cost by dividing that cost by (1 - 0.068)

b. Bonds are generally a safer investment than are stocks

Which of the following statements are true based on the historical record for 1926-2013? a. Risk free securities produce a positive real rate of return each year b. Bonds are generally a safer investment than are stocks c. Risk and potential reward are inversely related d. The normal distribution curve for large company stocks is narrower than the curve for small company stocks e. Returns are more predictable over the short term than they are over the long term

c. Capital gains yield and total return

Which of the following yields on a stock can be negative? a. Dividend yield b. Capital gains yield c. Capital gains yield and total return d. Dividend, capital gains, and total return e. Dividend yield and total return

e. U.S. Treasury bills

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2013? a. Long-term government bonds b. Small company stocks c. Large company stocks d. Long-term corporate bonds e. U.S. Treasury bills

e. Small-company stocks

Which one of the following categories of securities had the most volatile annual returns over the period 1926-2013? a. Long-term corporate bonds b. Large-company stocks c. Intermediate-term government bonds d. U.S. Treasury bills e. Small-company stocks

c. Small company stocks

Which one of the following earned the highest risk premium over the period 1926-2013? a. Long term corporate bonds b. US treasury bills c. Small company stocks d. Large company stocks e. Long term government bonds

d. US treasury bills

Which one of the following had the least volatile annual returns over the period of 1926-2013? a. Large company stocks b. Inflation c. Long term corporate bonds d. US treasury bills e. Intermediate term government bonds

d. Low probability of financial distress

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm? a. Exceptionally high depreciation expenses b. Very low marginal tax rate c. Substantial tax shields from other sources d. Low probability of financial distress e. Minimal taxable income

e. A decrease in the portfolio standard deviation

Which one of the following indicates a portfolio is being effectively diversified? a. An increase in the portfolio beta b. A decrease in the portfolio beta c. An increase in the portfolio rate of return d. An increase in the portfolio standard deviation e. A decrease in the portfolio standard deviation

b. Principal payment on long-term debt

Which one of the following is a marketed claim against a firm's cash flows? a. Tax payment to the IRS b. Principal payment on long-term debt c. Payment of employee wages d. Payment for warranty work on a product produced by the firm e. Payment of external legal and accounting fees

e. Red Herring

Which one of the following is a preliminary prospectus? a. Tombstone b. Green shoe c. Registration statement d. Rights offer e. Red Herring

c. Systematic

Which one of the following is a risk that applies to most securities? a. Unsystematic b. Diversifiable c. Systematic d. Asset-specific e. Total

a. Reducing the number of stocks held in the portfolio

Which one of the following is least apt to reduce the unsystematic risk of a portfolio? a. Reducing the number of stocks held in the portfolio b. Adding bonds to a stock portfolio c. Adding international securities into a portfolio of US stocks d. Adding US treasury bills to a risky portfolio e. Adding technology stocks to a portfolio of industrial stocks

d. All securities in an efficient market are zero net present value investments

Which one of the following statements best defines the efficient market hypothesis? a. Efficient markets limit competition b. Security prices in efficient markets remain steady as new information becomes available c. Mispriced securities are common in efficient markets d. All securities in an efficient market are zero net present value investments e. Profits are removed as a market incentive when markets become efficient

b. 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 concerning a portfolio beta? a. Portfolio betas range between -1 and +1 b. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio c. A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification d. A portfolio of US treasury bills will have a beta of +1 e. The beta of a market portfolio is equal to zero

c. The required return on assets is equal to the weighted average cost of capital

Which one of the following statements is correct in relation to M&M Proposition II, without taxes? a. The cost of equity remains constant as the debt-equity ratio increases b. The cost of equity is inversely related to the debt-equity ratio c. The required return on assets is equal to the weighted average cost of capital d. Financial risk determines the return on assets e. Financial risk is unaffected by the debt-equity ratio

b. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects

Which one of the following statements is correct? a. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project b. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects c. Firms will correctly accept or reject every project if they adopt the subjective approach d. Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate e. The pure play approach should only be used with low-risk projects

e. Markets tend to respond quickly to new information

Which one of the following statements related to market efficiency tends to be supported by current evidence? a. It is easy for investors to earn abnormal returns b. Short run price movements are easy to predict c. Markets are most likely only weak form efficient d. Mispriced stocks are easy to identify e. Markets tend to respond quickly to new information

c. The model is dependent upon a reliable estimate of the market risk premium

Which one of the following statements related to the capital asset pricing model approach to equity valuation is correct? Assume the firm uses debt in its capital structure. a. This model considers a firm's rate of growth b. The model applies only to non-dividend-paying firms c. The model is dependent upon a reliable estimate of the market risk premium d. The model generally produces the same cost of equity as the dividend growth model e. This approach generally produces a cost of equity that equals the firm's overall cost of capital

c. 2010-2013

Which one of the following time periods is associated with low rates of inflation? a. 1941-1942 b. 1974-1976 c. 2010-2013 d. 1980-1984 e. 1988-1990

c. Reward to risk ratio

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly? a. Variance b. Standard deviation c. Reward to risk ratio d. Beta e. Risk premium

a. Firm is earning just enough to pay for the cost of the debt

You have computed the break-even point between a levered and an unlevered capital structure. Ignore taxes. At the break-even level, the: a. Firm is earning just enough to pay for the cost of the debt b. Firm's earnings before interest and taxes are equal to zero c. Earnings per share for the levered option are exactly double those of the unlevered option. d. Advantages of leverage exceed the disadvantages of leverage e. Firm has a debt-equity ratio of .50