FNCE Chapter 7-9

In capital budgeting, the net ___________ determines the value of a project to the company.

Present Value

Initial public offerings of stock occur in the ___________ market.

Primary

NPV accounts for the size of the project and thus mitigates the effects of ______________.

Scale

The trading of existing shares occurs in the ____________ market.

Secondary

How is preferred stock like a bond?

Some preferred stock has credit ratings, like bonds. Preferred stock sometimes has a sinking fund, giving ti a set maturity like bonds. Preferred shareholders receive a stated dividend, similar to interest on a bond. Preferred shareholders receive a stated value if the firm liquidates, like bondholders.

Mota Motors has eight directors on its board, two of whom go up for election each year. This is an example of a :

Staggered board

The goal of many successful organizations is a(n) _____________________ rate of growth in dividends.

Steady

When the stock is being valued does not pay dividends,

The dividend growth model can still be used.

What are the advantages of the payback period for management?

The payback period method is ideal for short projects. The payback period method is easy to use. It allows lower level managers to make small decisions effectively.

When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near-term price) as a cash flow is that:

When discounted to present value, a stock price in the distant future is nearly zero.

Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:

Zero

If the growth rate (g) is zero, the capital gains yield is _____.

Zero

You expect the following dividends from ABC stock: Year 1 - $3.00 Year 2 - $2 Year 3 - $1 You expect that from year 4 onward, the dividend will grow at a constant 3% growth rate. If your required rate of return is 7%, what is your estimate for current stock price?

$26.39

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?

$5.94

Dusty corporation has an issue of preferred stock that pays a dividend of 7% of its state value, which is $100. What would be a commonly used name for that preferred stock?

$7 preferred.

One requirement of the dividend growth model is:

g < R

The two most important stock markets in the U.S. are the New York Stock Exchange and ______________________

the NASDAQ

Saxon Company is considering a project that will generate net income of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?

20.48%

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1-year return is ____________ percent.

5

A zero-growth model for stock valuation is distinguished by a ___________________.

Constant dividend amount

Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself a board member that represents his interests?

Cumulative voting

What are advantage(s) of AAR?

Is easy to compute Needed information is always available.

IRR continues to be very popular in practice, partly because:

It gives a rate of return rather than a dollar value.

One reason corporations use staggered boards is that:

It makes takeover attempts less likely to be successful.

If a project has multiple internal rates of return, which of the following methods should be used?

NPV MIRR

What occurs in the primary market?

Newly-issued stocks are initially sold.

WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No minority shareholder would have enough votes to win any seat on the board.

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

One vote per share held.

Preferred stock has preference over common stock in the:

Payment of dividends Distribution of corporate assets.

When cash flows are conventional, NPV is

Positive for discount rates below the IRR. Negative for Discount rates above the IRR Equal to zero when the discount rate equals the IRR.

The dividend yield is determined by dividing the expected dividend by:

The current price (P0)

The IRR is the discount rate that makes the NPV of a project equal to _______________.

Zero.

The largest number of NYSE members are registered as ___________________

Commission brokers.

T/F: Investing more money in a project is a guarantee of greater profits.

False

A person who brings buyers and sellers together is called a(n) _______________________

Broker

Capital ___________ is the decision-making process for accepting and rejecting projects.

Budgeting

The IRR rule can lead to bad decisions when ___________ or _____________.

Cash flows are not conventional Projects are mutually exclusive

Payback period tells the time it takes to break even in an _____________ sense. Discounted payback period tells the time it takes to break even in an ______________ or financial sense.

Accounting Economic

The constant-growth model infers that __________________

Dividends change at a constant rate.

The value of a firm is the function of its ___________ rate and its _____________ rate.

Growth; discount

The most important alternative to NPV is the _________ method.

Internal Rate of Return

What are features of a common stock?

It has no special preference in bankruptcy It has no special preference in receiving dividends It generally has voting rights

Examples of mutually exclusive investments?

Two different choices for assembly lines that will make the same product. A restaurant or a gas station on the same piece of land.

What are weaknesses of the payback method?

Cash flows received after the payback period are ignored. Time value of money principles are ignored The cutoff date is arbitrary.

Matthews Company has two classes of common stock, and each share represents the same proportion in the company. Class A has 2 votes for each share. Class B has one vote per share. Which class is more valuable?

Class A

NASDAQ has which of these features?

Computer Network of securities dealers Multiple market maker system

The three special case patterns of dividend growth include:

Constant Growth Non-Constant Growth Zero Growth

Which one of the followings is true about dividend growth patterns? Dividends never grow. Dividends always grow at a differential rate. Dividends always grow at a constant rate. Dividends may grow at a constant rate.

Dividends may grow at a constant rate.

The price of a share of common stock is equal to the present value of all ___________ future dividends.

Expected.

T/F: The discounted payback rule has an objective benchmark to use in decision-making.

False

A PE ratio that is based on estimated future earnings is known as a _____________ PE ratio.

Forward

An asset's value is determined by the present value of its _____________ cash flows.

Future

The profitability index is calculated by dividing the PV of the ______________ cash flows by the initial investment.

Future

The point at which the NPV profile crosses the horizontal axis is the:

Internal Rate of Return

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?

Internal Rate of Return Net Present Value

One common reason for having two classes of common stock with different voting rights is:

It is easier for insiders such as founding families to maintain control of the company.

Most voting in large corporations is done by proxy because:

Most small shareholders do not attend the annual meeting

When cash flows are conventional, 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.

A(n) _________ project does not rely on the acceptance or rejection of another project.

Independent.

When cash flows are conventional, NPV is _______________ if the discount rate is above the IRR.

Negative

The discounted payback period has what weaknesses?

Loss of simplicity as compared to the payback method Exclusion of some cash flows Arbitrary cutoff date

The three attributes of NPV are that it:

Uses all the cash flows of a project. Discounts the cash flows properly. Uses cash flows.

What is the price in one year for a stock that pays a dividend in one year of $2 with a growth of 8% and a required return of 10%?

$108

Scott Corporation does not pay dividends. The PE ratio for its industry is 13.3, and Scott's EPS were $1.47. At what price should Scott's stock trade?

$19.55

Stock price reporting has increasingly moved from traditional print media to the __________________ in recent years.

Internet

All else constant, the dividend yield will increase if the stock price _______________

Decreases

Steps involved in the discounted payback period in order starting with the first step.

Discount the cash flows using the discount rate. Add the discounted cash flows. Accept if the discounted payback period is less than some pre-specified number of years.

NPV________ cash flows properly

Discounts

The PI rule for an independent project is to _________________ the project if the PI is greater than 1.

Accept

What is the price of a stock at the end of one year (P1) if the dividend for Year 2 (Div2) is $5, the price for Year 2 (P2) is $20, and the discount rate is 10%?

$22.73

What is the value of a stock if next year's dividend is $6, the discount rate is 11% and the constant rate of growth is 3 percent?

$75

What is the price of a stock if its dividend a year from now is expected to be $3.20, the discount rate is 9 percent, and the constant rate of growth is 5 percent?

$80

What are expected cash flows to investors in stocks?

Capital Gains Dividends

Fundamentally, the business of the NYSE is to attract and process ____________.

Order flow

A project should be _________________ if its NPV is greater than zero.

Accepted

T/F: The MIRR function eliminates multiple IRRS and should replace NPV

False

What entities declare the dividend?

The board of directors.

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%?

2.91

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.7%

The NYSE differs from the NASDAQ primarily because the NYSE has

A physical location Specialists An auction market

The internal rate of return is a function of ______________.

A project's cash flows.

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

A target average accounting return.

The basic NPV investment rule is:

Accept a project if the NPV is greater than zero If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference. Reject a project if its NPV is less than zero.

Is a company required to pay preferred dividends?

No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid.

The capital budgeting method allows lower management to make smaller, everyday financial decision effectively.

Payback method.

The amount of time needed for the cash flows from an investment to pay for its initial cost is the?

Payback period

For a project with conventional cash flows, the NPV is __________ if the required return is less than the IRR, and it is ___________ if the required return is greater than the IRR.

Positive, Negative

Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles crosses at 15% (where the NPVs are positive), which of the projects has higher internal rate of return?

Project Beta

According to the basic IRR rule, we should:

Reject a project if the IRR is less than the required return

Internal Rate of Return (IRR) must be compared to the __________ in order to determine the acceptability of a project.

Required Return

NPV accounts for the size of the project and thus mitigates the effects of __________.

Scale

How does timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime.

An increase in the size of the first cash flow will decrease the payback period, all else held constant.

What information do we need to determine the value of stock using the zero-growth model?

Annual dividend amount Discount Rate

A person who brings buyers and sellers together is called a(n) __________________

Broker

Which of the following projects is acceptable if the average accounting return is required to be at least 20%?

Restaurant: Average Income = $450,00, Average Book Value = $2,180,000 Book Store: Average Income = $140,000, Average Book Value = $600,000

The payback period rule __________ a project if it has a payback period that is less than or equal to a particular cutoff date.

Suggests accepting

The point at which the NPV profile crosses the vertical axis is the:

Sum of the cash flows of the project

A benchmark PE ratio can be determined using:

The PEs of similar companies A company's own historical PEs

Why is it more difficult to value common stock than it is to value bonds?

The rate of return required by the market is not easily observed. Common Stock cash flows are not known in advance. The life of a common stock is essentially forever.

T/F: It can be advantageous to have a staggered board because it provides "institutional memory".

True

T/F: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

T/F: The crossover rate is the rate at which the NPVs of two projects are equal.

True

T/F: Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.

True

What are usually rights of common shareholders?

Voting rights. The right to purchase a proportional share of new stock issues. The right to a proportional share of dividends paid.