FINC 3511: Final

Which of the following will increase a company's retained earnings breakpoint?

An increase in its net income.

What is a measure of market risk which is the extent to which the returns on a stock move with the market?

Beta

___________ occurs when the introduction of a new product causes sales of existing products to decline.

Cannibalization

Business risk is concerned with the operations of the firm. Which of the following is NOT associated with (or not a part of) business risk?

Changes in required returns due to financing decisions.

__________ have control of the firm since they have the right to elect a firm's directors.

Common stockholders

The primary contribution of finance to total social welfare is its:

Contribution to the efficient allocation and use of resources.

_________ are effects of a project on cash flows in other parts of the firm.

Externalities

True or False: A call provision gives the investor the right to force the issuer to buy the bonds back before maturity.

False

True or False: A companys bond rating is not affected by its financial performance and provisions in the bond contract.

False

True or False: A sinking fund provision in a bond contract gives the issuer the right to redeem the bonds under specific terms prior to the normal maturity date.

False

True or False: An example of a primary market transaction is buying 100 shares of Wal-Mart stock from your uncle.

False

True or False: As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.

False

True or False: Dividend policy is independent of capital structure decisions.

False

True or False: Empirical studies show that the CAPM is completely valid.

False

True or False: For virtually all portfolios, the riskiness of the portfolio is a weighted average of the riskiness of the individual assets in the portfolio with the weights equal to the fraction of the total portfolio funds invested in each asset.

False

True or False: If a firm is experiencing a period of non-constant growth, its stock price cannot be calculated as the present value of expected dividends.

False

True or False: If the firm maximizes EPS, it will maximize stockholder wealth.

False

True or False: If the market is semistrong-form efficient, you can expect to outperform the overall market by observing the past price history of an individual stock.

False

True or False: In general, an increase in the corporate tax rate would cause firms to use less debt in their capital structures.

False

True or False: Increasing a firm's return on common equity will definitely increase the stockholders wealth.

False

True or False: Investment risk refers only to the chance that some unfavorable event will occur.

False

True or False: Managerial actions are the only determinant of a firm's stock value.

False

True or False: Managers should always undertake actions that result in a transfer of wealth from bondholders to stockholders.

False

True or False: Studies almost unanimously show that you cannot make an abnormal profit in the U.S. market by using inside information.

False

True or False: The Irrelevance Theorem (Modigliani and Miller) argues that investors prefer dividends to capital gains.

False

True or False: The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stock electronically.

False

True or False: The clientele effect can explain why companies tend to vary their dividends on a year-to-year basis.

False

True or False: The cost of capital used to evaluate a project should be the cost of the specific type of financing used to fund that project.

False

True or False: The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.

False

True or False: The present value of a perpetuity cannot be found since it is an annuity that goes on forever.

False

True or False: The tax preference theory suggests that a company can increase its stock price by increasing its dividend payout ratio.

False

True or False: There is virtually no link between capital budgeting and stock values.

False

True or False: Two firms with the same dividend and growth rate must also have the same stock price.

False

True or False: Whereas economic value added focuses on the effects of managerial action since the inception of the company, market value added focuses on managerial effectiveness in a given year.

False

Under the Bird-in-the-Hand Theory, if a firm decreases its dividend level, what will happen to its value of equity?

Go down

Under the Information Content Hypothesis, if a firm decreases its dividend level beyond what investors expected, what will happen to its value of equity when the new dividend is announced?

Go down

Under the Bird-in-the-Hand Theory, if a firm increases its dividend level, what will happen to its value of equity?

Go up

Under the Information Content Hypothesis, if a firm increases its dividend level beyond what investors expected, what will happen to its value of equity when the new dividend is announced?

Go up

Suppose all assumptions of the Independence Hypothesis of Capital Structure are true EXCEPT corporate interest payments are tax deductible. What does this imply for debt versus equity financing?

Increasing the level of debt in the firm will increase the value of the firm.

________ projects are projects whose cash flows are not affected by the acceptance of other projects.

Independent

What effect does considering the current system of personal taxation have on an investor's choice of receiving dividends or capital gains?

Investors will prefer to receive capital gains

Land Land Land, Inc. has a debt ratio of 0.3. The average debt ratio for the firm's industry is 0.4. Based on this information you know that:

LLL has relatively less debt than the average firm in the industry.

Land Land Land, Inc. has a debt ratio of 0.6. The average debt ratio for the firm's industry is 0.4. Based on this information you know that:

LLL has relatively more debt than the average firm in the industry.

Land Land Land, Inc. has a current ratio of 2.0. The average current ratio for the firm's industry is 2.5. Based on this information you know that:

LLL is less liquid than the average firm in the industry.

Land Land Land, Inc. has a current ratio of 2.0. The average current ratio for the firm's industry is 1.5. Based on this information you know that:

LLL is more liquid than the average firm in the industry.

Land Land Land, Inc. has a total asset turnover ratio of 2.0. The average current ratio for the firm's industry is 2.5. Based on this information you know that:

LLL less efficiently utilizes its assets than the average firm in the industry.

Land Land Land, Inc. has a total asset turnover ratio of 3.0. The average total asset turnover ratio for the firm's industry is 2.5. Based on this information you know that:

LLL more efficiently utilizes its assets than the average firm in the industry.

The portion of the interest rate that compensates the investor for investments that are difficult to convert quickly into cash

Liquidity premium

The primary goal of a publicly-owned firm interested in serving its stockholders should be to:

Maximize shareholder wealth.

What bonds are issued by state and local governments?

Municipal bonds

________ projects are a set of projects where only one can be accepted.

Mutually exclusive

_________ is the return on the best alternative use of an asset, or the highest return that will not be earned if funds are invested in a particular project.

Opportunity cost

Under the Information Content Hypothesis, if a firm increases its dividend level by the amount that investors expected, what will happen to its value of equity when the new dividend is announced?

Remain unchanged

___________ is a technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or base-case, situation.

Scenario analysis

__________ is a technique in which key variables are changed one at a time and the resulting changes in the NPV are observed.

Sensitivity analysis

A bond with a face value of $1,000 currently sells for a discount. Which of the following statements is most correct?

The bond's yield to maturity is greater than its coupon rate.

Holmes Aircraft recently announced an increase in its net income, yet its net cash flow declined relative to last year. Which of the following could explain this performance?

The company's depreciation expense declined.

Which of the following does NOT affect a firm's business risk?

The degree of financial leverage.

If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?

The yield on the 10-year bond is less than the yield on a 1-year bond.

What bonds are issued by the Federal government and have no default risk?

Treasury bonds

The interest earned on most municipal bonds is exempt from federal taxes.

True

True of False: Convertible bond are bonds that may be converted (exchanged) into shares of common stock, at a fixed price, at the option of the bondholder.

True

True or False: A business might choose to organize as a corporation rather than as a sole proprietorship or a partnership because corporations generally find it easier to raise capital.

True

True or False: A firm's capital structure policy affects its weighted average cost of capital.

True

True or False: According to the "trade-off theory," an increase in the costs of bankruptcy would lead firms to reduce the amount of debt in their capital structures.

True

True or False: All else equal, short-term bonds have more reinvestment rate risk than do long-term bonds.

True

True or False: Beta from the CAPM can be used to measure the market risk of a project.

True

True or False: Capital budgeting and security valuation use many of the same general concepts.

True

True or False: Double taxation is a significant disadvantage to the corporate form of organization.

True

True or False: FV = PV + interest earned

True

True or False: Increasing the threat of corporate takeover is likely to reduce agency conflicts between stockholders and managers.

True

True or False: Many actions that help a firm increase the price of its stock also benefit society at large.

True

True or False: Most firms today have in place strong codes of ethical behavior, yet there are no obvious answers for many of the ethical questions facing many companies.

True

True or False: One problem with following a residual dividend policy is that it can lead to erratic dividend payouts that may prevent the firm from establishing a reliable clientele of investors who prefer a particular dividend policy.

True

True or False: Signaling theory suggests firms should in normal times maintain reserve borrowing capacity that can be used if an especially good investment opportunity comes along.

True

True or False: Socially responsible actions that increase costs may have to be put on a mandatory basis.

True

True or False: The before-tax cost of debt is the yield-to-maturity adjusted for flotation costs.

True

True or False: The constant growth model takes into consideration the capital gains earned on a stock.

True

True or False: The present value (future value) of an uneven cash flow stream is the sum of the present values (future values) of each of the individual cash flows.

True

True or False: The value of a bond is the present value of the future cash flows from the bond (consisting of the par value at maturity and all intervening coupon payments).

True

True or False: The weighted average cost of capital for a given capital budget level is a weighted average of the marginal cost of each relevant capital component that makes up the firm's target capital structure.

True

True or False: There is no tax effect to consider when calculating the component cost of preferred stock for capital budgeting purposes.

True

True or False: Turnover ratios (such as inventory turnover, fixed assets turnover, and total assets turnover) focus primarily on how effectively the firm uses its assets to generate revenue.

True

Wetsdale Financial Company and Commerce Financial Company have the same total assets, the same total assets turnover, and the same return on equity. However, Wetsdale has a higher return on assets than Commerce. Which of the following can explain these ratios?

Wetsdale has a higher profit margin and a lower debt ratio than Commerce.

If your firm has an unlimited capital budget, all projects are independent, and a project has a Net Present Value that is greater than zero:

Your firm should accept the project.

If your firm has an unlimited capital budget, all projects are independent, and a project has a Net Present Value that is less than zero:

Your firm should not accept the project.

A partial amortization loan requires a final larger than usual payment that is called:

a balloon payment.

The concept of the time value of money generally implies that:

a dollar today is worth more than a dollar in the future

The New York Stock Exchange (NYSE) is:

a secondary market.

A cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected is called:

a sunk cost.

A bond that pays no annual interest but is sold at a discount below the par value is called:

a zero coupon bond.

Since preferred stock dividends are fixed, valuing preferred stock is roughly equivalent to valuing:

a zero growth common stock.

Risk in a revenue-producing project can best be adjusted for by:

adjusting the discount rate upward for increasing risk.

A table showing precisely how a loan will be repaid which gives the required payment each due date and a breakdown of interest versus principal is:

an amortization schedule

A loan that is repaid in equal payments over its life with each payment including a portion of interest and principal is:

an amortized loan

An annuity whose payments occur at the end of each period is called:

an ordinary annuity.

Investment banking firms:

are primary market participants and facilitate the issuance of new securities

What are the three major categories of items found on the balance sheet?

assets, liabilities, and equity

A long-term contract under which a borrower agrees to make payments of interest and principal on specific dates is called a:

bond.

If investment return is stated in dollars, to make a decision regarding return adequacy you also need to know:

both the scale of investment and the timing of the return

The process of planning expenditures on assets whose cash flows are expected to extend beyond one year is called:

capital budgeting

What are the three major categories of current assets?

cash, accounts receivable, and inventory

Prices for capital:

change in response to shifts in supply and demand conditions

The real risk-free rate of interest:

changes over time depending on economic conditions

The arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied (interest-on-interest) is called:

compounding

Economic value added differs from accounting profit in that it:

considers the cost of equity capital while accounting profit does not.

Bonds issued by corporations that are exposed to default risk are called:

corporate bonds.

What is the stated annual interest rate on a bond called?

coupon interest rate

The present value of a single sum to be received in the future ________ as the interest rate (discount rate) increases.

decreases

The present value of a sum due in the future ________ as the years to receipt increases.

decreases

Net cash flow is generally defined as net income plus:

depreciation and amortization

The process of finding the present value of a cash flow or a series of cash flows is called:

discounting.

The __________ is the true interest rate earned over a one-year period. It is the actual change expected over the one-year period.

effective annual interest rate

Comparisons of investment alternatives with different compounding periods should be made based on the:

effective annual interest rate.

If a coupon bond is selling at par, its current yield:

equals its yield to maturity.

The condition under which the expected return on a security is just equal to its required return is:

equilibrium

Financial intermediaries:

facilitate the transfer of funds from savers to demanders of capital

The price at which investors are indifferent between buying or selling a security is called the:

fair (equilibrium) value.

All else equal, if a bond's yield-to-maturity increases its price will _______.

fall

Commercial banks, mutual funds, and life insurance companies are examples of:

financial intermediaries

The optimal capital structure from the Tradeoff Theory is the mix of debt and equity where:

firm value is maximized and the cost of capital is minimized

The NPV calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the:

firm's cost of capital.

The cost of new common stock (external equity) is generally higher than the cost of retained earnings (internal equity) because of:

flotation costs.

The future value of an annuity due will be _________ than the future value of an ordinary annuity (assuming all else equal).

greater

The present value of an annuity due will be ________ than the present value of an ordinary annuity (assuming all else equal).

greater

The effective annual rate of interest is:

greater than or equal to the nominal interest rate.

All else equal, ________ bonds have more reinvestment rate risk than ________ bonds.

high-coupon; low-coupon

High beta projects are projects with _________ risk and should be evaluated using a _______ cost of equity capital.

high; high

All else being equal, an increase in accounts receivable will ________ a company's current ratio?

increase

If households increase the amount of money they borrow from their local banks, it will lead to a(n) ____________ in the cost of funds?

increase

The future value of a single sum will ______ if the interest rate increases.

increase

The net cash flows attributable to an investment project which represent the change in the firm's total cash flow that occurs as a direct result of accepting the project are called:

incremental cash flows

The __________ is the value of an asset that in the mind of a particular investor is justified by the facts.

intrinsic value

The coefficient of variation:

is a stand-alone risk measure; measures risk per unit of return

Retained earnings (from the balance sheet):

is the total amount of income over time that has been reinvested in the firm.

Suppose you know that your firm is facing relatively poor prospects but needs new capital. If you also know that investors do not have this information, signaling theory would predict that you would:

issue equity to share the burden of decreased equity returns between old and new shareholders.

Disregarding risk, if money has time value, the present value of a given sum will be _________ than its future value.

less

If a bond is selling for a premium, this implies that the bond's yield to maturity is _________ its coupon rate.

less than

Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist without such a call provision will generally be _________ the YTM with a call provision.

lower than

Money markets are:

markets for short-term, highly liquid debt securities.

Asset management ratios:

measure how effectively a firm is managing its assets.

Debt management ratios:

measure the amount of debt the firm uses.

With a bond, what generally represents the amount of money the issuer promises to repay on the maturity date?

par value

The CAPM says that the relevant risk of an individual asset is its:

portfolio or market risk

Buying 100 shares of a new issue of Home Depot common stock is an example of a _________ transaction.

primary market

Capital _________ is the term that means the size of the capital budget is constrained.

rationing

Opportunities to respond to changing circumstances giving mangers the opportunity to influence a projects outcome are often called _________.

real options

When calculating the component cost of debt for capital budgeting purposes for profitable, tax-paying firms, the tax adjustment:

reduces the component cost of debt

_________ is the risk that a decline in interest rates will lead to a decline in income from a bond portfolio.

reinvestment rate risk

Depreciation:

represents the allocation of costs of assets over their useful lives

What are the two major categories of items found on an income statement?

revenue (income) and expenses (costs)

The discount rate that applies to a particular risky stream of income is called the:

risk-adjusted discount rate.

In financial management the primary agency relationships are those between:

shareholders and managers AND shareholder (& managers) and debtholders

Profitability ratios:

show the combined effects of all areas of the firm on operating results.

The balance sheet:

states the firms financial position at a specific point in time.

The income statement:

summarizes the firms revenues and expenses over an accounting period.

IRR indicates a project is deemed desirable (acceptable) when:

the IRR is greater than or equal to the risk-adjusted cost of capital

NPV indicates a project is deemed desirable (acceptable) when:

the NPV is greater than or equal to zero

The default risk premium

the amount of return attributable to the risk that the promised payments will not be made

The rate of return on the best available investment of equal risk is called:

the opportunity cost rate

For a portfolio, the weighted average of the expected returns for the individual assets in the portfolio with the weights equal to the fraction of the total portfolio funds invested in each asset is called the:

the portfolio expected return

The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the:

the return on the particular project examined.

If sales, assets, and common equity remain constant, but the profit margin on sales goes up, what happens to return on total assets?

the return on total assets will go up

A basic concept in finance says that investors will take on financial risk if:

they view the return as adequate relative to the risk

The examination of ratios over time is called:

trend analysis

Disadvantages of the sole proprietorship form of organization include:

unlimited liability and difficulty in transferring ownership

Initial public offering (IPO):

when a companys stock is offered to the public for the first time.

The rate of return earned on a bond if it is called before its maturity date is its:

yield-to-call.

The rate of return earned on a bond if it is held until maturity is its:

yield-to-maturity.