FINN 3603 Exam 1
Who owns treasury stock?
the issuer of the stock
The main goal of a proxy fight is:
to replace the current management team
A bond's sinking fund is managed by the:
trustee
According to the top-down approach, what is the operating cash flow if sales are $200,000, total cash costs are $190,636, and the tax bill is $1,144?
$200,000 - 190,636 - 1,144 = $8,220
What is a premium bond?
A bond that sells for more than face value.
_______ indicates preference in position over other lenders.
Seniority
True or false: A line of credit from a bank sets the maximum amount that the bank is willing to lend to the business.
True
If a firm increases its level of debt, its beta will ___.
also increase
Another term for an annuity due is _____.
an annuity in advance
The current ratio computes the relationship between ____.
current assets and current liabilities
Investors cannot attain a portfolio below the feasible set or opportunity set because they cannot ____.
increase the correlation between two securities increase the standard deviation of the securities lower the return on individual securities
The sales of cyclical firms are ______ sensitive to the business cycle than are the sales of non-cyclical firms.
more
In general, NPV is ___.
negative for discount rates above the IRR. equal to zero when the discount rate equals the IRR. positive for discount rates below the IRR.
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following capital budgeting techniques is least used.
profitability index
The correct discount rate on a project ______ the expected return on a financial asset of comparable risk.
should be
The most popular dollar value for the par value of a corporate bond is ______.
$1,000
What is the beta for stock A if the covariance between stock A and the market is 1.5 and the variance of the market is 2.5?
1.5/2.5 = .6
If Net Income is 77 million dollars, depreciation is 13 million dollars, and deferred taxes are 2 million dollars, what is the cash flow from operating activities?
92 million
How can a positive relationship between expected return on a security and its beta be justified?
Because the difference between the return on the market and the risk-free rate is likely to be positive.
Which of the following are annuities?
Installment loan payments Monthly rent payments in a lease
What are the two areas where preferred stockholders have greater rights relative to common stockholders?
Payment of dividends Distribution of assets in the event of liquidation
Who acts as a link between shareholders and top management?
The board of directors
True or false: The correct discount rate on a project should be the expected return on a financial asset of comparable risk.
True
True or false: The realization (timing) of income can be useful to a firm.
True
In general, which shape does the term structure of interest rates usually have?
Upward sloping
A line of credit from a bank sets ______ amount the bank is willing to lend.
a maximum
Discounting is the process of converting ______ dollars into a ______ value.
future; present
An increase in a firm's total asset turnover will ______ the sustainable growth rate.
increase
A staggered election occurs when:
only a fraction of the board are elected at a time
What are the implications of the time value of money concept?
A dollar today is worth more than a dollar tomorrow; A dollar tomorrow is worth less than a dollar today
Which of these are required to calculate the current value of a bond?
Applicable market rate Coupon Par value Time remaining to maturity
Which of the following are fixed for a conventional bond?
Coupon payments The principal
The _________ identity can help to explain why two firms with the same return on equity may not be operating in the same way.
DuPont
When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____.
decrease
U.S. Treasury securities considered to be risk-free because they have minimal, if any, ____ risk.
default
When using regression analysis with stock returns as inputs, the _____ beta is estimated.
equity
The issuance costs of bonds and stocks are referred to as ______ costs.
flotation
As the compounding frequency increases, the future value will:
increase
Cash flow analysis is popular because:
it is harder to "spin" and mislead
Financial planning is a(n) _____ process.
iterative
The WACC is the minimum return a company needs to earn to satisfy ___.
its bondholders its stockholders
The price at which willing buyers and sellers would trade is called _______ value.
market
To estimate a firm's equity cost of capital using the CAPM, we need to know the ___.
market risk premium stock's beta risk-free rate
An increase in ______ will increase beta.
operating leverage financial leverage
Opportunity costs are classified as ____ costs in project analysis.
relevant
Common-size statements are used for comparing firms with differing ____.
sizes
What is the value of a bond if the present value of interest cash flows is $200 and the present value of the par value to be received when the bond matures is $750?
$200 + $750 = $950 PV of interest cash flows + PV of par value at maturity = total value of bond
A project's NPV without flotation costs is $750,000 and its flotation costs are $25,000. What is the true NPV?
$725,000
If a firm has $15 million of debt with a debt beta of 0.2 and $40 million of equity with equity beta of 2.2, then the firm's asset beta is ____.
1.65
Which of the following is true?
A company can deduct interest paid on debt up to 30% of EBIT when computing taxable income.
When is the seniority of debt of particular importance?
In the event of default by the corporation
What is the equation for estimating operating cash flows using the top-down approach?
OCF = Sales - Cash costs - Taxes
Which of the following is (are) true about allocated costs?
These costs are allocated to more than one project. These costs benefit more than one project.
What does TIPS stand for?
Treasury Inflation-Protected Securities
The US government borrows money by issuing:
Treasury notes Treasury bonds
True or false: In general, the stock market is more transparent than the bond market.
True
The ______ is the overall expected return the firm must earn on its existing assets to maintain its value if the firm is levered.
WACC
What does WACC stand for?
Weighted average cost of capital
According to the CAPM, when is a security considered overpriced?
When its expected return plots below the SML
If a firm has multiple projects, each project should be discounted using _____.
a discount rate commensurate with the project's risk
A deed of trust is also known as a:
bond indenture
Dividends ______ business expenses.
are not
In general, financial companies in the US typically issue:
debentures
If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______$1,000.
less than
Warrants are _____ valuable if stock prices are rising.
more
The payments in a ________ amortization loan are NOT based on the life of the loan.
partial
Which of the following are common shapes for the term structure of interest rates?
upward sloping downward sloping flat
A project's NPV without flotation costs is $1,000,000 and its flotation costs are $50,000. What is the true NPV?
$1,000,000 - 50,000 = $950,000
What is the present value of $1,000 to be received in 10 years if the interest rate is 12 percent, compounded semiannually?
$1,000/[1 + (.12/2)]10 × 2 = $311.80
What is the value of a zero coupon bond that matures in 15 years if it promises to pay $5,000 at maturity, assuming an interest rate of 7.5 percent compounded annually?
$5,000/(1.075)15 = $1,689.83
If a firm has $10 million of debt with a debt beta of .4 and $30 million of equity with equity beta of 2, then the firm's asset beta is ____.
($10/$40)(.4) + ($30/$40)(2) = 1.6
What is Stock B's beta if the covariance between stock B and the market is 3.75, and variance of the market is 2.5?
3.75/2.5 = 1.5
If a firm's retention ratio is 80 percent and its ROE is 5 percent, then the dividend growth rate is ___.
80% × 5% = 4%
Which of the following is a perpetuity?
A constant stream of cash flows forever
What is the primary source of dividends?
After-tax profits
Which group of equityholders can participate in the election of the board of directors?
All common stockholders with a right to vote
Which of the following will be true in a world with homogeneous expectations?
All investors will hold the market portfolio.
What does a normal return depend upon?
All relevant information available to shareholders
Which compounding interval will result in the lowest future value assuming everything else is held constant?
Annual
For a diversified investor, what is the best way to measure the systematic risk of an individual security?
Beta
What is the appropriate measure of risk for an individual security if an investor holds a diversified portfolio?
Beta
How is a conventional bond different from a zero coupon bond?
Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeroes can not. A conventional bond pays periodic coupon interest whiles zeroes make no interest payments.
What is the most common type of bond issued by US industrial companies?
Debentures
Debentures commonly pledge which type of property as security?
Debentures do not pledge specific properties
Which of these risks is addressed by bond ratings?
Default risk
Dot's financial planning model shows assets are projected to increase by $800,000 but liabilities and equity increase by $395,000. What is the external financing need (EFN)?
EFN = $800,000 - $395,000 = $405,000
Which of the following could be mortgaged?
Equipment Building Land
The par value of a bond is almost always higher than the face value.
False
True or false: A bond's value is not affected by changes in the market rate of interest.
False
True or false: A firm evaluating two mutually exclusive projects can accept both projects.
False
Which of the following are true?
Fixed costs do not change as quantity changes. Variable costs change with changes in quantity.
Which type of amortization is most commonly used in the real world for mortgages and car loans?
Fixed payment
Which of the following payment methods amortizes a loan?
Fixed payments that result in a zero loan balance Interest plus fixed amount
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets.
What is systematic risk?
It is a risk that pertains to a large number of assets.
Which of the following variables are required to calculate the value of a bond?
Market yield Coupon rate Remaining life of bond
Which of the following are real-world examples of annuities?
Mortgages Pensions Leases
You must know the discount rate to compute ____, while the discount rate is necessary to apply ___.
NPV; IRR Reason: You must know the discount rate to compute NPV, while the discount rate is necessary to apply IRR (because you need it for the decision rule).
According to the bottom-up approach, what is the OCF if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?
Note that depreciation has already been subtracted in calculating EBIT, so it must be added back. OCF = EBIT - taxes + depreciation, or EBIT(1-t) + depreciation $600 × (1−.30)1-.30 + $1,800 = $2,220
Which of the following is the equation for estimating operating cash flows using the tax shield approach?
OCF = (Sales - Costs) × (1 - Tax rate) + Depreciation × Tax rate
What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?
PI = (($80/1.12) + ($20/1.122)) / $30 = 2.91
What is the present value of the annual interest payments on a 20-year, $1,000 par value bond with a 5 percent coupon paid annually, if the yield on similar bonds is 10 percent?
PV = (.05 × $1,000) × (1 - 1/1.1020)/.10 = $425.68
Which of the following is the formula for the present value of a growing perpetuity?
PV = C/(r - g)
Which of the following are ways to amortize a loan?
Pay principal and interest every period in a fixed payment. Pay the interest each period plus some fixed amount of the principal.
What does ROA equal?
Profit margin x Total asset turnover ROE/Equity multiplier Profit margin = Net Income/Sales, and total asset turnover = Sales/Assets. So profit margin X total asset turnover = Net Income/Sales X Sales/Assets = Net Income/Assets = ROA
Which one of the following is the correct equation for computing return on assets (ROA)?
ROA = Net income/Total Assets
How is sustainable growth calculated when equity used in the calculation of ROE is the beginning value?
ROE x b
Which of the following is an example of an opportunity cost?
Rental income likely to be lost by using a vacant building for an upcoming project
Suppose a firm has a target debt-equity ratio of 2.5. What is the firm's target capital structure weight for common stock?
S/(S + B) = 1/3.5 = 28.57%
What are the two sets of accounting books?
Tax books Shareholders' books
What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30 percent?
Tax shield = $1,800 × .3 = $540
Which of the following statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
Taxes are based on the difference between the book value and the sales price. Book value represents the purchase price minus the accumulated depreciation. There will be a tax savings if the book value exceeds the sales price.
Which has a higher value, the bid price quote or the asked price quote?
The asked price quote is higher.
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
The bid price The asked price
In a publicly traded corporation, which of the following is true regarding the relationship between the board of directors and management?
The board of directors advises and oversees the work of management. Top management is hired by the board of directors.
Which of the following is true about a growing annuity?
The cash flows grow for a finite period
Who are the parties to the bond indenture agreement?
The corporation and the bondholders
Why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change
Which of the following are weaknesses of the payback method?
The cutoff date is arbitrary. Cash flows received after the payback period are ignored. Time value of money principles are ignored.
According to the capital asset pricing model, what is the expected return on a security with beta of 1?
The expected return on the market
What is included in the bond indenture?
The face value of the bond The call provisions The coupon rate
Which of the following are needed in order to compute the variance of a portfolio consisting of two stocks, A and B?
The market value, in dollars, of the investments in stocks A and B The covariance between stocks A and B The variances of stocks A and B
What are the advantages of the payback period method for management?
The payback period method is easy to use. It allows lower level managers to make small decisions effectively. The payback period method is ideal for minor projects.
What key assumption makes the promised yield different from the expected return?
The promised yield assumes no default risk.
What does the clean price for a bond represent?
The quoted price, which excludes accrued interest
What is expected return?
The return that an individual expects to earn over the next period
What is a corporate bond's yield to maturity (YTM)?
YTM is the expected return for an investor who buys the bond today and holds it to maturity. YTM is the prevailing market interest rate for bonds with similar features.
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of more than one corporation.
Based on the capital asset pricing model (CAPM) there is generally ___ relationship between beta and the expected return on a security.
a positive Reason: The market risk premium is the slope of the CAPM. As long as the market risk premium is positive, the relationship between beta and the expected return on a security will be positive.
The IRR rule summarizes the information about the project in:
a single rate of return
According to the CAPM, a security is considered underpriced when its expected return plots ___ the SML.
above
Incremental cash flows of a project are changes in a firm's cash flows that occur as a direct consequence of ____.
accepting a project
The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accepts
A balance sheet reflects a firm's _________ value on a particular date.
accounting
Financial statements report:
book values
In finance, the value of a firm depends on its ability to generate ______.
cash flows
WACC is used to discount ______ ______.
cash flows
Which of the following should be discounted when determining the feasibility of a capital budgeting project(s)?
cash flows
it is difficult to manipulate
cash flows
Corporate finance emphasizes _____ while financial accounting emphasizes ______.
cash flows; earnings
Investment in net working capital arises when ___.
cash is kept for unexpected expenditures inventory is purchased credit sales are made
Taxes represent which of the following:
cash outflow
Which of the following items are used to compute the current ratio?
cash; accounts payable
A corporate bond's yield to maturity ____.
changes over time can be greater than, equal to, or less than the bond's coupon rate
Junior debt cannot be subordinated to:
common stock
The idea behind ______ is that interest is earned on interest.
compounding
As depreciation ______, operating cash flows will _______.
decrease; decrease increase; increase
A provision whereby the corporation is prohibited from calling the bonds for a stipulated time is known as a(n) ______ call provision
deferred
When a corporation is prohibited from calling bonds for 7 years, it is subject to a(n):
deferred call provision
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the ______ rate raised to the nth power.
discount
One method for estimating the cost of equity is based on the ______ model.
dividend discount
The decline in the ratio of total debt to the book value of equity for US nonfarm, non-financial firms declined modestly from 1995 to 2013. This modest decline is understandable because as long as net income exceeds __________, retained earnings will be positive, raising the book value of equity.
dividends
A firm should only undertake a project if its expected return is ______ that of a financial asset of comparable risk.
equal to or greater than
Depreciation is the accountant's estimate of the cost of _____ used up in the production process.
equipment
If the firm is all-equity, the discount rate is equal to the firm's cost of ______ capital.
equity
Regression analysis on stock returns against the risk premium on the market can be used to estimate the ______ beta of a levered firm.
equity
The two main types of securities issued by a corporation are debt securities and ______ securities.
equity
The short run for a firm is the period of time during which ________.
output can vary; some costs are fixed
A common-size balance sheet expresses accounts as a percentage of ______.
total assets
Standard deviation measures ______ risk while beta measures ______ risk.
total; systematic
Which one of the following constitutes an infrequent annuity?
$100 once every two years
If you invest $100 at a stated annual rate of 10 percent compounded quarterly, how much more money will you have in 10 years than if the rate was compounded annually?
$100 × (1 + .10/4)40 - $100 × (1.10)10 = $9.13
A firm has cash flows of $100 at the end of years 1 - 4. What is the net present value of an investment in this firm if we pay $300 to purchase the firm and the discount rate is 10 percent?
$100 × [(1 - (1/1.10)4))/.10] - $300 = $16.99
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
$100/$1,000 = 10%
What is the present value of $100 each year for 20 years at 10 percent per year?
$100{[1 - (1/(1.10)20)]/0.10}= $851.36
What is the present value of an ordinary annuity that pays $100 per year for three years if the interest rate is 10 percent per year?
$100{[1 - (1/(1.10)3)]/.10} = $248.69
Alpha Manufacturing has interest expense of $12 million, total assets of $184 million, sales of $176 million, long-term debt of $16.4 million, and net income of $15 million. How will interest expense be recorded in the common-size income statement?
$12m/$176m = 6.82%
What is the PI for a project with an initial cash outflow of $50 and a present value of all future cash flows of $150?
$150/ $50 = 3
A small project has cash flows of -$10 and $45, and a large project has cash flows of -$30 and $70. What is the incremental NPV at a discount rate of 10%?
$2.73 Reason: The answer is the NPV of the difference in cash flows between the two projects. In this case, the time 0 cash flow difference is (-$30-(-$10)=-$20) and the second cash flow difference is $70-$45 = 25. NPV = -$20+ (25/1.10) = $2.73. You can also take the difference in the NPVs of the two projects.
Weston's financial planning model shows assets are projected to increase by $2.7 million while liabilities and equity increase by $1.5 million. What is the external financing need (EFN)?
$2.7m - 1.5m = $1.2m
If a firm's current assets are $100 and its current liabilities are $80, then its net working capital is:
$20
Suppose you have a car loan that lasts 6 years, a discount rate of 7%, and a loan balance of $15,000 requiring annual payments. What is the annual payment?
$3,146.94
If a firm needs $500 million in new assets and has projected retained earnings of $200 million, what is the external financing needed?
$300 million.... $500m - $200m
Suppose you paid off a $1,200 loan by paying $400 in principal each year plus 10 percent annual interest over a 3-year period. What is the total payment (interest plus principal) in Year 3?
$400 + ($1,200 - 800) × .10 = $440
Alder Inc. has net income of $403,000, operating earnings of $640,000, sales of $1.23 million, and total assets of $1.48 million. What is the return on assets?
$403,000/$1.48m = 27.23%
What is the equation for determining the real interest rate?
(1+Nominal Int Rate)/(1+Inflation Rate) - 1
If the nominal rate is 5 percent and the annual rate of inflation is 2 percent, what is the real rate of return?
(1.05/1.02)-1 = 2.94%
What is the real interest rate if the nominal annual interest rate is 10 percent and the annual inflation rate is 4 percent?
(1.10/1.04) - 1 = 5.77%
The formula for finding the net present value of a cash outflow now, a positive cash flow in 1 year, a positive cash flow in 2 years, and a positive cash flow in 3 years is:
-C0+ C1/(1 + r)1 + C2/(1 + r)2+ C3/(1 + r)3
At the end of a project, the company sold a machine for $50,000 with a book value of $10,000. Assuming a tax rate of 21%, what is the after tax salvage value?
.21 x ($50,000 - $10,000) = $41,600
A firm with $900,000 in sales, cash on hand of $1,150,000, liabilities of $400,000 and total assets of $2 million has a total asset turnover of ______ times.
.45.... Asset turnover ratio = total sales/ total assets; $900,000/$2m = .45
What is the expected return of a portfolio consisting of stocks A and B if the expected return is 10 percent for A and 15 percent for B? Assume you are equally invested in both the stocks.
.5 × 10% + .5 × 15% = 12.5%
A $1,000 par value bond that was purchased for $1,100 has a coupon rate of 5%. What is the annual interest income?
0.05 × $1,000 = $50
The weighted average cost of capital (WACC) formula, for a firm with no debt or preferred stock will have a WACC of:
1 × Cost of equity Reason: Because the weight of debt is zero in an all-equity firm, the WACC for that firm is the cost of equity.
The computation of variance requires 4 steps. Place the steps in the correct order from the first step to the last step.
1. Calculate the expected return 2. Calculate the deviation of each return from the expected return 3. Square each deviation 4. Calculate the average squared deviation
From highest to lowest, rank the following compounding periods effective annual rates:
1. continuous 2. weekly 3. semiannual 4. annual
Alpha Co. has interest expense of $1.2 million, total assets of $84 million, sales of $76 million, long-term debt of $16.4 million, and net income of $12.1 million. How will interest expense be recorded in the common-size income statement?
1.58%...... $1.2m/$76m = 1.58%
Notes are generally used to classify debentures with a maturity of less than ______ years.
10
How many variance and covariance terms will be needed in order to calculate the variance of a portfolio consisting of 100 stocks?
100 variance terms and 9,900 covariance terms Reason: Var terms = 100 Cov terms = N2 - N = 1002 - 100 = 9,900
To find the future value annuity factor from a time value of money table, read down the rows to find T = 10 and across the columns to find 10 percent. The factor where that column and row intersect is _____.
15.937 Reason: To find the future value annuity factor from a time value of money table, read down the rows to find T = 10 and across the columns to find 10 percent. The factor where that column and row intersect is 15.937.
The federal corporate tax rate in the U.S. became a flat _____ percent with the passage of the Tax Cuts and Jobs Act of 2017.
21
Which one of the following is generally thought of as a risk-free security?
3-month Treasury bill
If a firm needs $300 million in new assets and has projected retained earnings of $72.4 million, what is the external financing needed?
300 - 72.4 = 227.6
According to the Rule of 72, at 18% per year, it will take _____ years to double your money. Hint: round your answer to the nearest whole number of years.
4
What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
4% + 1.2(12% - 4%) = 13.6%
Suppose the risk-free rate is 5 percent, the market rate of return is 10 percent, and beta is 2. Find the required rate of return using the CAPM.
5% + (2 × (10% - 5%)) = 15%
To find the present value of an annuity of $100 per year for 10 years at 10 percent per year using the tables, look up the present value interest factor which is ______ and multiply that by ______.
6.1446; $100 Reason: To find the present value of an annuity of $100 per year for 10 years at 10 percent per year using the tables, look up the present value interest factor which is 6.1446 and multiply that by $100.
If the retention ratio is 60 percent and ROE is 20 percent, then the growth rate of dividends is:
60% × 20% = 12%
Alpha Co. has cost of goods sold of $77 million, net income of $9.6 million, sales of $120 million, and total assets of $150 million. A common-size income statement will show cost of goods sold of ___ percent and a net profit of ____ percent.
64.2; 8%..... $77m/$120m = 64.2% & $9.6m/$120m = 8%
Rock Construction has current assets of $45 million, total liabilities and equity of $67 million, and sales of $59 million. How would current assets be expressed on a common-size balance sheet?
67%..... $45m/$67m = 67% Recall that Assets = liabilities + equity
If the risk-free rate is 3 percent, the market risk premium is 7 percent, the industry beta is 1, and the firm beta is 2, the cost of equity will be ____ percent less if the industry beta is used instead of the firm beta.
7% (1 - 2) × 7% = -7%
How long will it take to double your money at 10% per year?
72 ÷ 10 = 7.2 years
What is the legal document that describes a mortgage?
A mortgage trust indenture
Which of the following represents an infinite and constant stream of cash flows?
A perpetuity
In a financial plan using the percentage of sales approach, why is it assumed that some assets increase with sales?
Additional working capital and fixed assets are needed to support growth
Which of the following are reasons why an investor cannot attain a portfolio above the feasible or opportunity set?
An investor cannot decrease the correlation between the two securities An investor cannot decrease the standard deviation of individual securities An investor cannot increase the return on individual securities
Which of the following correctly describes the relationship between depreciation, income, taxes, and investment cash flows?
As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase.
Which of the following are reasons why corporate treasurers prefer the use of book values when measuring debt ratios?
Bond covenant restrictions are based on book values. Credit rating firms use book values. Stock markets are very volatile.
If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.
Bond value = $320 + 900 = $1,220
Select all that apply Which of the following are true?
Book values are often similar to market values for debt. Ideally, we should use market values in the WACC.
Which of the following are examples of collateral?
Building Common stock Equipment
How are most votes cast at the annual meetings of large public corporations?
By proxy
For both academics and practitioners, the pendulum has swung over to the _______ for estimating the cost of equity capital.
CAPM
Ralph has $1,000 in an account that pays 10 percent per year. Ralph wants to give this money to his favorite charity by making three equal donations at the end of the next 3 years. How much will Ralph give to the charity each year?
Calculate the payment using the PV of an annuity at 10% for 3 years. $1,000/[(1 - 1/1.103)/.10] = $402.11
What type of bonds can be redeemed before the maturity date by the issuing corporation?
Callable bonds
Which of the following is given greater importance in capital budgeting problems in corporate finance?
Cash flows
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
Which of the following can cause a firm's beta to change over time?
Changes in technology Changes in product line Changes in leverage
Who enjoys the right to elect the board of directors in a corporation?
Common stockholders
Which of these affect a bond's yield to maturity?
Coupon rate Current price Par value
Which two groups usually compete to obtain votes from shareholders during a proxy fight?
Current management and an outside group of shareholders
What are three important features of Treasury notes and bonds?
Default-free Highly liquid Taxable
How does depreciation affect the operating cash flows?
Depreciation expense reduces the taxable income and taxes, and increases the operating cash flow.
What is a discount bond?
Discount bonds are bonds that sell for less than the face value.
What are some differences in the income received by common stockholders and the income received by bondholders?
Dividends are not based on the par value of stock, but interest is generally based on a bond's par value. Common stock pays dividends while bonds pay interest. Dividends are not fixed, but interest is generally a fixed dollar amount.
What can we say about the dividends paid to common and preferred stockholders?
Dividends to preferred stockholders are fixed. Dividends to common stockholders are not fixed.
How is preferred stock classified for tax purposes?
Equity
A 10-year AAA corporate bond is most apt to have a yield that ____ the yield on a 10-year AAA state government bond.
Exceeds
Which six factors determine the yield on a bond?
Expected future inflation Real rate of return Interest rate risk Taxability Liquidity Default risk
Firms generally maintain two sets of books, one for the IRS and the other for the purposes of generating financial statements according to the __________________.
FASB
If $100 earns compound interest for 2 years at 10 percent per year, the future value will be ____.
FV = $100 × 1.10 2 = $121
True or false: Common stockholders receive special preference in receiving dividends.
False
True or false: Discounting involves determining the future value of present cash flow.
False
True or false: If a corporation uses cumulative voting and you are a minority shareholder who wants a seat on the board, you will prefer staggering.
False
True or false: If a firm stays in the same industry, its beta will never change.
False
True or false: In an upward-sloping term structure, the long-term rates will be lower than the short-term rates.
False
True or false: Plain vanilla bonds are exotic bonds with unique features.
False
True or false: Projects should always be discounted at the firm's overall cost of capital.
False
True or false: Receiving $10 today has the same value as receiving $1 today and $9 one year from now.
False
True or false: The CAPM is the only method to compute the cost of equity.
False
True or false: The Rule of 72 is a short cut approach to estimate the time needed to double your interest rate.
False
True or false: The book value of common stock is based on the current trading price while the market value of common stock is based on the issue price at the time of an IPO.
False
True or false: The inflation premium will be higher if the rate of inflation is low.
False
True or false: Systematic risk will impact all securities in every portfolio equally.
False Reason: While it is possible, it is highly unlikely that systematic risk (such as changes in interest rates) will affect all firms equally.
True of false: Operating cash flow includes capital spending and working capital requirements.
False. Operating cash flow is the cash flow generated by business activities, excluding financing, capital spending, or changes in net working capital.
Which of the following are factors that affect beta?
Financial leverage The cyclical nature of revenues Operating leverage
In the formula for the future value of an annuity, the expression in brackets is equal to the:
Future value interest factor for an annuity
The _______ (IRR/NPV) rule summarizes the information about a project in a single rate of return. This single rate gives people a simple way of discussing the rate of return of projects. (Enter abbreviation only.)
IRR
Which of the following are premiums determine the yield on a bond?
Interest rate risk Expected future inflation Liquidity Default risk Taxability
Which of the following are true about risk aversion?
Investors who are more risk averse will tend to demand relatively higher compensation for taking risk. Risk aversion implies that investors will not take risks unless they are adequately compensated for it. The degree of risk aversion varies among investors.
What is a sinking fund?
It is a fund set up for the repayment of bonds.
What is a real rate of return?
It is a rate of return that has been adjusted for inflation. It is a percentage change in buying power.
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
It is likely to decrease. It may eventually be almost totally eliminated.
What is a protective covenant?
It is the part of the bond indenture that protects bondholders by limiting the actions of the corporation.
What is a normal return?
It is the return that shareholders predict or expect.
Which of the following are true regarding the face value of a bond?
It is the value stated on a bond certificate. It is the principal value of the bond.
Which is the promised yield on a bond?
It is the yield based on the current price and expected cash flows, assuming no default.
What are the two basic effects of staggering elections?
It makes it harder for minority shareholders to elect a board member under cumulative voting. It makes takeover attempts more difficult.
Which of the following is true about the WACC?
It represents the marginal cost of capital. It is also referred to as the discount rate that is used to discount cash flows in capital budgeting problems.
If a corporation has 10 seats on the board of directors, how many directors will be elected each year with a staggered election?
Less than 10 board members
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?
NPV = -$95 + ($107/1.06) = $5.94
Identify the three main sources of cash flows over the life of a typical project.
Net cash flows from salvage value at the end of the project Cash outflows from investment in plant and equipment at the inception of the project Net cash flows from sales and expenses over the life of the project.
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the U.S. and Canada?
Net present value Internal rate of return
What is the difference between nominal cash flow and real cash flow?
Nominal cash flow is the actual dollars to be received. Real cash flow refers to the cash flow's purchasing power.
What is the present value of the annual interest payments on a 10-year, $1,000 par value bond with a coupon rate of 10 percent paid annually, if the yield on similar bonds is 9 percent?
PV = (.10 × $1,000) × (1 - 1/1.0910)/.09 = $641.77
What are the cash flows involved in the purchase of a 5-year zero-coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
Pay $800 today and receive $1,000 at the end of 5 years
Which of the following cash flows appear in the financing activities section of the accounting statement of cash flows?
Payment of dividends; Repurchase of stock; Retirement of long-term debt
Which types of shareholders are unlikely to attend the annual meeting to cast their vote?
Preferred stockholder A minority shareholder
Match the component ratios of ROE with their correct calculations.
Profit Margin = Net income/ Sales Total Asset Turnover = Sales/Assets Equity Multiplier = Assets/ Total Equity
How are TIPS different from traditional bonds?
Promised payments are specified in real terms
Which of the following institutions issue bonds that are traded in the bond market?
Public corporations The federal government State governments
What does ROE equal?
ROE/Equity multiplier Profit margin x Total asset turnover ROE = Net Income/Equity, which is also Net Income/Assets X Assets/Equity. ROA = Net Income/Assets, and Equity multiplier = Assets/Equity, so ROE = ROA X Equity Multiplier.
What is the approximate formula for estimating the real interest rate?
Real interest rate = Nominal interest rate - Inflation rate
A firm needs to sell enough equity to raise $950,000 after covering the flotation costs of 5 percent. How much will it pay in flotation costs?
Reason: $950,000 = Amount Raised × (1 - .05) Amount Raised = $1,000,000 Flotation Costs = $1,000,000 - 950,000 = $50,000
What is the return on a portfolio that consists of: $50,000 in an index fund, $30,000 in a bond fund, and $20,000 in a foreign stock fund? The expected returns are 7 percent, -3 percent, and 18 percent, respectively.
Reason: .5 × 7% + .3 × -3% + .2 × 18% = 6.2%
Assume these market averages: dividend growth rate = 10 percent; average market dividend yield = 3 percent; average 1-year T-bill rate = 2 percent. What is the cost of equity capital for a firm with a beta of 2?
Reason: RM = 3% + 10 = 13% Cost of Capital = 2% + 2(13%- 2%) = 24%
Which three of the following are most apt to create problems when comparing financial statements for multiple firms?
Seasonality; Differing accounting methods; Differing fiscal years
Which of the following statements is/are true of the relationship between shareholders and the board of directors?
Shareholders elect the board of directors. The board of directors' role is to protect the interests of shareholders. The board of directors acts as a link between shareholders and management.
What is preferred stock?
Stock that enjoys preference with regard to payment of dividends and distribution of assets over common stockholders.
What is treasury stock?
Stock the firm has repurchased
A firm's target capital structure weights are evenly split between debt and equity. What is the firm's target debt-equity ratio?
Target D/E = .5/.5 = 1
Which is the largest security market in the world in terms of trading volume?
The U.S. Treasuries market
Which of the following statements are true about expected return?
The actual return can be higher or lower than the expected return. The expected return can be calculated as the average of the returns in previous periods. The expected return reflects an estimate that can be based on sophisticated forecasts of future outcomes.
A security has a beta of 1, the market risk premium is 8 percent, and the risk-free rate is 3 percent. What will happen to the expected return if the beta doubles?
The expected return will increase to 19% from 11%. Reason: 3% + 2 × 8% = 19%, which is less than double the original 11%
What is the most important item that can be extracted from financial statements?
The firm's actual cash flows
Which of the following are traditional financial ratio categories?
The five basic categories are Short-term solvency (or liquidity), long-term solvency (or financial leverage), asset management (or turnover), profitability, and market value.
Which portfolio will an investor who is very risk averse select from the opportunity set of risky assets?
The minimum variance portfolio
Why is the determination of the efficient set for 50 securities more complex than the determination of the efficient set for two securities?
The number of variance, return, and correlation calculations increases dramatically.
Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?
The operating cash flows from net sales over the life of the project
Identify a true statement about a project that has both positive and negative cash flows after first one.
The project should be accepted if the net present value of the project is greater than zero.
Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?
The rate of inflation Reason: The CAPM uses the risk-free rate, the beta of the stock, and the market risk premium to compute equity cost of capital. Inflation rate is not needed.
What is the expected return on a bond?
The return based on the current price and future cash flows adjusted for default risk.
According to the CAPM, what is the expected return on a stock if its beta is equal to zero?
The risk-free rate
What are the two components of the expected return on the market (RM)?
The risk-free rate (RF) The risk premium
According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?
The risk-free rate of return Reason: Risk-free rate + 0 × Market risk premium = Risk-free rate
Which of the following variables do we need to compute the beta for a company's stock?
The variance of the market index's returns. The covariance between the stock and the market index's returns.
Which of the following are true about U.S. Treasury instruments?
They are not expected to default at this time. They have never defaulted.
What do covariance and correlation measure?
They both measure how two random variables are related
Which of the following are true about optimal portfolios?
They offer the lowest risk for a given level of return. They offer the highest return for a given level of risk. They provide the best risk-return trade-off.
Why are the deviations of returns squared when computing variance?
This ensures that that the sum of the deviations is a positive number.
What information is needed to compute a bond's yield to maturity?
Time to maturity Coupon rate The bond's current price
What is the debt-equity ratio for a company with $3.5 million in total assets and $1.4 million in equity?
Total Debt = Assets - Equity ($3.5m - 1.4m)=$2.1 m Debt/Equity = $2.1m/$1.4m = 1.50 (Equation 3.5)
A firm with $600,000 in sales, cash on hand of $750,000, liabilities of $200,000 and total assets of $1 million has a total asset turnover of ______ times.
Total asset turnover=$600,000/$1m = .60
Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?
Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer. Treasury bonds are issued by the US government while corporate bonds are issued by corporations.
True or false: Interest earned on Treasury notes and bonds is taxable
True
True or false: NPV will be the same regardless of whether nominal or real cash flows are used.
True
True or false: The formula for finding the net present value of a cash outflow now, a positive cash flow in 1 year, and a positive cash flow in 2 years is -C0+ C1/(1 + r)1 + C2/(1 + r)2.
True
True or false: The formula for the present value of an annuity factor is {1-1(1+r)tr}1-1(1+r)tr.
True
True or false: The price you actually pay to purchase a bond will generally exceed the clean price.
True
True or false: The spreadsheet (Excel) formula for calculating the present value of $100 at the end of each year for 2 years at 10 percent per year is: PV(.1,2,-100,0).
True
True or false: According to CAPM, if the historical market risk premium is negative, we cannot justify a positive relationship between a security's expected return and its beta.
True Reason: The market-risk premium is the slope of the CAPM equation. Thus, if the market risk premium is negative, there is a negative relationship between expected return and beta.
True or false: A project with an initial cash outflow followed by a cash inflow has an NPV that is negatively related to the discount rate.
True. Reason: A project with an initial cash outflow followed by a cash inflow will have an NPV that will decrease as discount rates increase.
True or false: A good working knowledge of financial statements is desirable because such statements are the primary means of communicating financial information both within and outside the firm.
True. Financial statements are the primary means of communicating financial information both within and outside the firm.
What is a bond's yield to maturity (YTM)?
YTM is the expected return on a bond that is held until it matures
The present value interest factor for an annuity with an interest rate of 8 percent per year over 20 years is ____.
[1-(1/1.0820)]/.08 = 9.8181
For a project with a positive initial cash flow followed by negative cash flows, we should ___.
accept if the IRR is less than R
What does a balance sheet reflect about a firm?
accounting value on a specific date
Which of the following are included in cash flow from investing activities?
acquisition of fixed assets; sales of fixed assets
If investors have homogeneous expectations, they ___.
all possess the same estimates regarding expected returns, variances, and covariances
The discount rate for the firm's projects equals the cost of capital for the firm as a whole when ___.
all projects have the same risk as the current firm
Which one of these will decrease a firm's sustainable rate of growth?
an increase in the dividend payout ratio
One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.
arbitrary
When analyzing a project, sunk costs ____ incremental cash outflows.
are not
Collateral refers to any:
asset pledged on a debt
The cash flow identity states that cash flows from _____ should equal cash flows to creditors and equity investors.
assets
The cash flow identity states that cash flows from ______ should equal cash flows to creditors and equity investors.
assets
Liquidity refers to the ease of changing _________.
assets to cash
An annuity due is a series of payments that are made ____.
at the beginning of each period
According to the basic investment rule for NPV, a firm should ____.
be indifferent towards accepting a project if NPV is equal to zero reject a project if NPV is less than zero. accept a project if the NPV is greater than zero.
The sustainable growth rate is computed as ROE × b when equity used is at the ______ of the period.
beginning
Allocated costs arise when a specific expenditure ____.
benefits more than one project or division
The covariance between the stock and the market index's returns divided by the variance of the market index's returns represents the ______ for a company's stock.
beta
The slope of the characteristic line of a firm's returns versus those of the market is the ___.
beta
Protective covenants are designed to protect the interests of the:
bondholders
Corporate treasurers prefer to use ______ values when calculating debt ratios.
book
On the balance sheet, assets are listed at their _______ value.
book
The short run is a period when there are ________ costs.
both fixed and variable
Flotation costs are costs incurred to ____.
bring new security issues to the market
If there is a deferred call provision, whereby the corporation is prohibited from recalling the bonds, the bonds are said to be:
call protected
A callable bond:
can be called and redeemed by the corporation before the maturity date
The statement of cash flow explains changes in _____.
cash and equivalents
The cash flows from financing activities include changes in:
common stock; long-term debt
When investing in large US stocks, the reinvestment of dividends and capital gains generates:
compound interest
The APR is meaningful for comparisons only when the number of ______ per year is given.
compounding periods
Plain vanilla bonds are:
conventional bonds with typical bond features
A positive covenant specifies an action or rule that a:
corporation must abide by
The discount rate of a project is said to be its ________ of capital
cost
Two ways to measure the relationship between the returns of two securities are ______ and ______.
covariance correlation
The variance of the return on a portfolio with many securities is more dependent on the _______ between the individual securities than on the ______ of the individual securities.
covariances; variances
The cash flow identity states that cash flow from assets equals cash flows to ____.
creditors and stockholders
The difference between ROA and ROE reflects the use _____ of financing.
debt
What are the two main types of securities issued by a corporation?
debt and equity
A treasury bond is:
debt issued by the US government with a typical maturity of between 2-30 years
An important accounting goal is to report financial information to users in a way that is useful for _____.
decision making
The ratio of total debt to the book value of equity for US nonfarm, non-financial firms has ______ over time.
declined
A one-time profit from an asset sale makes it ______ to compare financial statements.
difficult
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
discounted payback period
According to the Rule of 72, to find the amount of time required for a sum of money to double in value, you:
divide 72 by the interest rate (%)
The _____ discount model requires estimation of the dividend yield and _____ rate.
dividend; growth
Common stockholders receive ______ income while bondholders receive ______ income.
dividend; interest
The net present value technique does not discount earnings because earnings ___.
do not represent real money
When expressing covariance between two securities, the ordering of variables:
does not matter
The discounted payback period ______ account for time value of money and the payback period ______ account for time value of money.
does; does not
A cyclical firm is one in which revenues go ______ in the contraction phase of the business cycle.
down
To smooth its earnings, a firm is more apt to sell appreciated property and realize the income on that sale when its other earnings are ________.
down
If the firm is all-_______, the discount rate is equal to the firm's _______ of equity capital.
equity; cost
When comparing projects with unequal lives, one should use which of the following methods:
equivalent annual costs
The goal of a rational, wealth-maximizing investor in developing a portfolio is to maximize the ___ and minimize the ____.
expected return; standard deviation
All else equal, when the rate of growth in sales or assets in a financial plan is higher, ______ financing needs will be greater.
external
When using an annuity table to find the present value of an annuity, you multiply the annuity cash flow by the present value interest _______ for annuities.
factor
The range of risk-return combinations possible with a portfolio of securities is captured by the opportunity set, which is also known as the ______ set.
feasible
An increase in a firm' s level of debt is an example of ___.
financial leverage
Changes in notes payables are included in the ______ section of the accounting statement of cash flows.
financing
The activity of making net payments to creditors and owners (excluding interest) is called a(n) ______ activity in the accounting statement of cash flows.
financing
A growing annuity has a(n) ____.
finite number of growing cash flows
The principal and coupon payments are ______ for a conventional bond.
fixed
_____ costs do not change as the quantity sold changes while _____ costs do change as the quantity sold changes.
fixed; variable
In the U.S., corporate taxes are which type of system following passage of the Tax Cuts and Jobs Act of 2017?
flat tax
An important advantage to a firm raising equity internally is not having to pay ___.
flotation costs
A limitation of bond ratings is that they ____.
focus exclusively on default risk
Cf*((1+r)t−1r)(1+r)t-1r is the formula for the ______ , value of an annuity.
future
All else equal, when the rate of growth in sales or assets in a financial plan is higher, external financing needs will be:
greater
Accept a project if its NPV is ______ zero.
greater than
In an inflationary environment, the nominal rate will be _________ the real rate.
greater than
The future value of $100 at 10 percent compounded semiannually is ______ the future value of $100 at 10 percent compounded annually.
greater than
You invest $100 today. With positive interest rates, the concept of future value implies that the future value of your $100 will be ____ $100.
greater than
A stream of cash flows that grows at a constant rate for a finite period is called a(n) _____.
growing annuity
To apply the dividend discount model to a particular stock, you need to estimate the ___.
growth rate dividend yield
Sunk costs are costs that ____.
have already occurred and are not affected by accepting or rejecting a project
The return per unit of risk of the optimal portfolio will be ______ compared to that of any other portfolio.
higher
The growth rate of dividends can be estimated using ___.
historical dividend growth rates security analysts' forecasts the retention ratio × ROE
When valuing a complete business enterprise, the same process that is used for individual projects can be used. However, the analysis is complicated because a _________ must be used, and a terminal firm value must be determined.
horizon
Interest expenses incurred on debt financing are ______ when computing cash flows from a project.
ignored
Interest on municipal bonds is ______.
ignored for tax purposes but included as income for FASB accounting
A world where all investors possess the same estimates of expected returns, variances, and covariances is:
imaginary
An increase in depreciation expense will ____ cash flows from operations.
increase
An increase in the profit margin will ______ a firm's sustainable growth rate.
increase
If a firm increases its debt-equity ratio it will _____ its sustainable rate of growth.
increase
If sales are made on credit, net working capital will _____.
increase
If the inflation rate increases, the nominal rate of interest will ______.
increase
If the tax rate increases, the value of the depreciation tax shield will ____.
increase
In a financial plan using the percentage of sales approach, as total assets increase, total liabilities and equity will:
increase
Synergy will ______ the sales of existing products.
increase
When evaluating a project with an initial cash inflow followed by cash outflows, the NPV will _____ as the discount rate rises.
increase
Stockholders' equity ________ when retained earnings increase.
increases
The expected return on the market will increase if the risk-free rate _________ or if the market risk premium _____.
increases; increases
Buying new cost-cutting equipment affects operating cash flows by:
increasing pretax income increasing taxes increasing the depreciation deduction
A way to evaluate mutually exclusive projects is to analyze the cash flows.
incremental
cash flows are the difference between the cash flows of the firm with the project and the cash flows of the firm without the project.
incremental
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite
The inflation premium is the additional return demanded by investors to compensate for _____.
inflation
The net present value of a project's cash flows is divided by the ______ to calculate the profitability index.
initial investment
________ expenses incurred on debt financing are ignored when computing cash flows from a project.
interest
In reality, most firms cover the equity portion of their capital spending with ___.
internally generated cash flow
Cash flows from the acquisition and sale of fixed assets are located in the _______ activities section of the accounting statement of cash flows.
investing
In general, a corporate bond's coupon rate ____,
is fixed until the bond matures
The Fisher effect hypothesizes that the real rate of return ____.
is invariant to the rate of inflation
The federal government can raise money from financial markets to finance its deficits by ___.
issuing bonds
If a firm issues no debt, its average cost of capital will equal ___.
its cost of equity
A market is considered transparent if ____.
its prices and trading volume are easily observed
The industry beta may be a better estimate than the firm's own beta due to the ______ standard error of the firm estimate.
larger
For a positive annual percentage rate (APR) and multiple (more than one) compounding periods per year, the EAR is always ______ the APR.
larger than
The U.S. Treasuries market is the ______ security market in the world (based on trading volume).
largest
In an infrequent annuity, the payments occur ______.
less than once a year
A traditional (non-growing) annuity consists of a(n) ________ stream of cash flows for a fixed period of time.
level
A firm with debt in its capital structure is said to be:
levered
_______ refers to the quickness and ease with which assets can be converted to _______.
liquidity; cash
The computation of equivalent annual costs is useful when comparing projects with unequal _____.
lives
When interest rates and inflation rates are _____, the approximation of the real interest rate becomes _____.
low; good high; poor
When comparing projects with different lives, one should choose the project with the ______ equivalent annual cost.
lower
If reinvestment of interest or dividends does not occur, then the future value of an investment will be _____ and the realized yield will be ____ than if reinvestment had occurred.
lower; lower
When bidding for a job, a competing firm can use the NPV approach to determine their bid. Once the bid is submitted, the firm will win the contract for the project if their bid is the:
lowest
A minimum variance portfolio has the ____.
lowest possible variance
A minimum variance portfolio will be characterized by its ___.
lowest possible variance lowest possible standard deviation
Financial economists prefer the use of ______ values when measuring debt ratios.
market
The variance of the return on a portfolio with many securities is _______ dependent on the covariances between the individual securities than on the variances of the individual securities.
more
______ companies prefer the CAPM to the DDM.
more
The concept of future value implies that a dollar today is worth ______ a dollar in the future, assuming positive interest rates.
more than
A requirement in the bond indenture that the corporation cannot invest in highly speculative projects is an example of a(n) ______ covenant.
negative
When cash flows are conventional, NPV is ______ if the discount rate is above the IRR.
negative
The bottom-up approach to calculating OCF starts with:
net income
Which of the following are examples of financing activities?
net payments to creditors; net payments to owners
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered in the analysis
When computing the IRR, the discount rate is:
not needed
The equation for determining the real interest rate has the nominal interest rate in the _____ and the inflation rate in the ______.
numerator; denominator
Allocated costs must be treated as relevant or incremental costs ___.
only if the costs being allocated are affected by the proposed project
Changes in _____ leverage and ______ leverage will affect beta.
operating; financial
Using your personal savings to invest in your business is considered to have an ________ because you are giving up the use of these funds for other investments or uses, such as, a vacation or paying off a debt.
opportunity cost
Suppose you paid a $1,200 loan off by paying $400 in principal each year plus 10 percent annual interest. How much is the interest payment in the second year of the loan?
ou are re-paying $400 each year. Interest is computed on the principal outstanding for the year, which is ($1,200 - 400) = 800. $800 × 0.1 = $80
Under capital budgeting, required working capital is classified as a cash ______.
outflow
Payments in a partial amortization loan are based on the amortization period, not the loan period. The remaining balance is then ____.
paid off in a lump sum bullet payment
The face value of a bond is also known as the ______ value of a bond
par
This capital budgeting method allows lower management to make smaller, everyday financial decisions easily is:
payback method
When using the spreadsheet (Excel) function for finding the PV of an annuity, it's a good idea to enter the ______ as a negative value.
payment
A loan might be repaid in equal _______ over a specific period of time.
payments/installments
Preferred stock ___.
pays a constant dividend pays dividends in perpetuity
The requirement that a corporation must maintain a current ratio of 2.5 is an example of a(n) ______ covenant.
positive
The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.
positive
For "normal" cash flows (the outflows occur before the inflows), the NPV is ______ if the discount rate is less than the IRR, and it is ______ if the discount rate is greater than the IRR.
positive; negative
The difference between the expected return on the market portfolio and the risk-free rate is the market risk _________.
premium
The formula for the ______ value interest factor of an annuity is {1-[1/(1+r)t]r}1-[1/(1+r)t]r.
present
The value of a firm can be found by taking the _____ value of all _____ cash flows.
present; future
Amortization is the process of paying off loans by regularly reducing the _________.
principal
Management may look _____ to shareholders and pay _____ tax on reported profit.
profitable; no
A negative covenant:
prohibits an activity by the corporation
Much of the voting in large public corporations is actually done by:
proxy
_______ voting occurs when a shareholder gives someone else the authority to vote on her behalf.
proxy
As a general rule, when estimating equivalent annual costs, ________ cash flows should be used.
real
Nominal interest rate - Inflation rate approximates the _________ interest rate.
real
Which of the following refers to a cash flows purchasing power?
real cash flow
Erosion will ______ the sales of existing products.
reduce
If the expected return of a project is below that of a financial asset of comparable risk, the firm should ______ the project.
reject
A firm evaluating two mutually exclusive projects can ___.
reject one of the projects reject both projects accept one of the projects
If a firm has a payback period of 3 years and a project has a payback period of 3.5 years, the project should be:
rejected
Opportunity costs are classified as:
relevant costs
According to the Fisher effect hypothesis, the real rate of return ______ as inflation increases.
remains the same
A project should only be accepted if its return is above what is ___.
required by investors
The rate used to discount project cash flows is known as the ___.
required return cost of capital discount rate
A sinking fund is used to:
retire debt
How is income defined?
revenue minus expenses
The risk-free security is ______.
riskless
Mortgage securities are:
secured by a mortgage on the real property of the borrower
Interest paid twice a year is known as ______ compounding.
semiannual
Depreciation × Tax rate represent the depreciation tax _________.
shield
When the term structure of interest rates is downward-sloping, ____.
short-term rates are higher than long-term rates
In the context of a portfolio of two securities, the opportunity set ___.
shows the range of risk-return combinations, based on various weights for the two securities
For debt, book values and market values are typically:
similar
The ____ of the characteristic line of a stock's returns versus those of the market measures the stock's systematic risk.
slope beta
________ financial statements provide for comparison of firms that differ in size.
standardized
An official accounting statement that helps to explain the change in cash and cash equivalents is called the _____.
statement of cash flows.
Fixed payment loans are typically used for which of the following:
student loans mortgages car loans
The NPV _____ the initial investment while the profitability index _____ the initial investment from the present value of all future cash flows.
subtract; divides
Cash flow from operations is calculated by adding depreciation to EBIT and ______ current taxes.
subtracting
The cost of capital is an appropriate name since a project must earn enough to pay those who ______ the capital.
supply
Beta measures the _______ risk of a security.
systematic
_____ income is the income subject to tax
taxable
_____ is the income subject to tax
taxable income
When valuing a firm with the weighted average cost of capital, the ________ value of the firm can be estimated by assuming a constant perpetual growth rate for cash flows beyond the horizon.
terminal
It is appropriate to use the approximate formula for estimating the real interest rate when:
the interest rate and inflation rate are low
If you own corporate bonds, you will be concerned about interest rate risk as it affects ____.
the market price of the bonds
When a firm evaluates a proposal to make an existing facility more cost effective, the cost savings must be large enough to justify:
the necessary capital expenditure
The discount rate for the firm's projects equals the cost of capital for the firm as a whole when all projects have ______ risk as the firm.
the same
The risk free measure for the risk-free rate should be ______ the risk-free rate used for the market risk premium.
the same as
When using nominal cash flows, the NPV will be _____ when using real cash flows.
the same as
If a corporation defaults on its bond issue, ______ represent(s) the bondholders.
the trustee
If a $1,000 par value bond is trading at a premium, the bond is:
trading for more than $1,000 in the market
Shareholders can exercise their right to vote in a public corporation by:
transferring the right through proxy vote attending the meeting in person
The first cash flow at the end of week 1 is $100, the second cash flow at the end of month 2 is $100, and the third cash flow at the end of year 3 is $100. This cash flow pattern is a(n) ______ type of cash flow.
uneven
Another name for idiosyncratic risk is ______ risk.
unsystematic diversifiable
The SML will be ____ if the expected return on the market is higher than the risk-free rate.
upward sloping
The weighted average cost of capital (RWACC) is the overall expected return the firm must earn on its existing assets to maintain its ___.
value
_______ will be less valuable if the underlying stock's price is falling.
warrants
One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future:
when economic conditions change quickly
Sometimes when the low bidder wins the bid on a project, it is because they have underbid the project. In other words, the bid they have submitted probably won't even cover the costs of the project. When this happens, the low bidder is said to suffer from the:
winner's curse
BC Corporation has net income of $176,000, sales of $1,982,000 and total assets of $2.24 million. What is the return on assets?
$176,000/$2.24m = 7.86%
BC Corporation has 1,800 shares outstanding and earned $2,700 last year on assets of $2 million and equity of $1.5 million. What is the PE ratio if the stock is currently selling at $18 per share?
$18/($2,700/1,800) = 12 times
Vera's has earnings per share of $3 and dividends per share of $1.20. The stock sells for $30 a share. What is the PE ratio?
$30/$3 = 10 times
If a firm's current assets equal $200 and its current liabilities equal $150, then its net working capital equals _____.
$50
Assume current assets = $48; fixed assets = $125, current liabilities = $42, and equity= $100. What is the total debt ratio?
.42..... Debt ratio is Debt/Total Assets. To compute debt, you need to subtract equity from assets. So Debt =($48 + 125 - 100) = $73, and Assets = ($48 + 125) =$173, and debt ratio =$73/$173 = 0.42
If Net Income is 97 million dollars, depreciation is 33 million dollars, and deferred taxes are 22 million dollars, what is the cash flow from operating activities?
152 million
What is depreciation?
A systematic expensing of an asset based on the asset's estimated life
Which of the following are often left out of most financial planning models?
Cash flow size, risk, and timing
True or false: Taxes can be a large cash outflow for a corporation.
True
When a firm pays out fewer dividends, it _________ the accounting value of its retained earnings.
increases
One of the most basic principles of finance is that rational individuals prefer to receive a dollar ____ than a dollar ______.
today; tomorrow
