Finance Exam 2 HW Questions
Which one of the following statements is correct, all else held constant?
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?
Ace Builders' cost of capital
An efficient capital market is best defined as a market in which security prices reflect which one of the following?
Available Information
Which one of the following methods of analysis ignores cash flows?
Average Accounting Return
Which one of the following methods of analysis is most similar to computing the return on assets (ROA)?
Average accounting return
Which one of the following statements is correct? A) The internal rate of return is the most reliable method of analysis for any type of investment decision. B) The payback method is biased against short-term projects. C) The modified internal rate of return is most useful when projects are mutually exclusive. D) The average accounting return is the most difficult method of analysis to compute. E) The net present value method is only applicable if a project has conventional cash flows.
B) The payback method is biased against short-term projects.
A broker is an agent who:
Brings buyers and sellers together.
Which one of the following types of securities has no priority in a bankruptcy proceeding?
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 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?
Current Market Value of the building
An agent who buys and sells securities from inventory is called a:
Dealer
Which one of the following defines the internal rate of return for a project?
Discount rate which results in a zero net present value 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?
Diversification
Which one of the following is the primary advantage of payback analysis?
Ease of Use
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?
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?
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
The Blackwell Group is unable to obtain financing for any new projects under any circumstances. Which term best applies to this situation?
Hard Rationing
Scenario analysis
Helps determine the reasonable range of expectations for a project's anticipated outcome.
All else constant, which of the following will increase the after-tax 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 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, 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, 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, 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 and IV only
Which one of the following is an example of systematic risk?
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 after-tax 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 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?
Incremental Cash Flows
The profitability index reflects the value created per dollar:
Invested
Inside quotes are defined as the:
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?
Market Risk
Which one of the following is the slope of the security market line?
Market Risk Premium
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.
Money spent last month repairing a damaged front fender
A specialist is a(n):
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?
Net Present Value
Which one of the following terms refers to the best option that was foregone when a particular investment is selected?
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 Expand
Which one of the following indicates that a project is expected to create value for its owners?
Positive Net Present Value
Which one of the following indicates that a project is definitely acceptable?
Profitability index greater than 1.0
Which one of the following best describes an arithmetic average 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?
Risk level of the project
Which one of the following describes systemic risk?
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
Which one of the following categories has the widest frequency distribution of returns for the period 1926-2008?
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?
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
Which one of the following refers to the option to expand into related businesses in the future?
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?
Sunk
The risk premium for an individual security is based on which one of the following types of risk?
Systematic
Which one of the following statements is correct?
The higher the expected rate of return, the wider the distribution of returns.
An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true?
The net present value is equal to zero.
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 increases rapidly to a higher price and then remains at that price.
Which one of the following best exemplifies unsystematic risk?
Unexpected increase in the variable costs for a firm
Portfolio diversification eliminates which one of the following?
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?
Weighted average cost of capital
Which one of the following is the pre-tax cost of debt?
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?
Zero
Semi-strong form market efficiency states that the value of a security is based on:
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:
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.
Sensitivity analysis
helps identify the variable within a project that presents the greatest forecasting risk.
The cost of preferred stock:
is equal to the stock's dividend yield.
Ignoring the option to wait:
may underestimate the net present value of a project.
Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio:
of each security must equal the slope of the security market line.
If the financial markets are semi-strong form efficient, then:
only individuals with private information have a marketplace advantage
If the financial markets are efficient then:
stock prices should only respond to unexpected news and events.
The beta of a risky portfolio (assuming no borrowing or shortselling) cannot be less than _____ nor greater than _____.
the lowest individual beta in the portfolio; the highest individual beta in the portfolio
Over the period of 1926-2008:
the risk premium on stocks exceeded the risk premium on bonds.
Standard deviation measures _____ risk while beta measures _____ risk.
total; systematic
