Exam 3 (Chapters 8-10)

When the stock being held does not pay dividends, _____________________________________.

the dividend growth model can still be used.

In modern stock exchanges and LOBs stand for what?

Electronic Limit Order Books

Stock =

Equity Ownership

If you can forecast P/E and EPS, you can forecast what?

Stock Price

Which of the following entities declares a dividend?

The board of directors

DDM: P0 =

The calculated value of the stock (what we think it should be worth)

What are the two types of orders?

Marker and Limit

A share of common stock is _______ (less/more) difficult to value in practice than a bond.

More

P/E Valuation is also known as?

Multiple Valuation

What is the term to describe if you choose one project you cannot choose another regardless of NPV or IRR?

Mutually exclusive projects

If NPV and IRR disagree use what?

NPV

An NYSE member who acts as a dealer in particular stocks is called a _________ market maker.

Designated

DDM: R =

Discount rate / required rate of return

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?

Discounted payback period

What are the two components of Required Rate of Return (R)?

Dividend Yield and Capital Gains Yield

DDM: Dt =

Dividend at time t

Common stock has no special preference either in receiving ___________ or in bankruptcy.

Dividends

The assumption of constant growth infers that _________.

Dividends change at a constant rate

The cash flows of a new project that come at the expense of a firms existing projects is called what?

Erosion

True or False: For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False

Sunk costs are costs that ____.

Have already occurred and are not affected by accepting or rejecting a project

Once cash flows have been estimated which of the following investment criteria can be applied to them - IRR - Payback period - YTM - The constant growth dividend discount model - NPV

IRR; Payback Period; NPV

Interest expenses incurred on debt financing are _________ when computing cash flows from a project

Ignored

An increase in depreciation expense will ________ cash flows from operations

Increase

Using the project specific (____________) cash flows we can calculate a project's net cash flow each year

Incremental

_______________ cash flows come about as a direct consequence of taking a project under consideration

Incremental

Which cash flows are to be considered when evaluating a project?

Incremental or Relevant: Cash flows that are encouraged should the project be taken on and net new cash flow should the project be taken on

The present value of all cash flows (after the initial investment) is divided by the ______ to calculate the profitability index.

Initial Investment

Net _________ value is a measure of how much value is created or added today by undertaking an investment

Present

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

Present value

P/E =

Price per Share / Earnings per Share

The IRR rule can lead to bad decisions when _________ or _________.

Projects are mutually exclusive; Cash flows are not conventional

The accelerated cost _________ system is a depreciation method under US tax law allowing for the accelerated write off of property under various classifications

Recovery

Erosion will ________ the sales of existing products

Reduce

The basic NPV investment rule is: - Reject a project if it's NPV is less than zero - Accept a project if the discount rate is above zero - Accept a project if the NPV is greater than zero - Accept a project if the NPV is less than zero - If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

Reject a project if it's NPV is less than zero; 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

A calculated NPV of 15,000 means that the project is expected to create a positive value for the firm and

Should be accepted if there is no capital rationing constraint

The NYSE member who acts as a dealer in a small number of securities is called a __________.

Specialist

The ________ alone principle is the assumption that evaluation of a project may be based on the projects incremental cash flows

Stand

According to the ___________ principle once the incremental cash flows from a project have been identified the project can be viewed as a "minifirm"

Stand-alone

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

Suggests accepting

Investment firms that are active participants in stocks assigned to them are called ________ liquidity providers.

Supplemental

What is the main idea of NPV?

Take on project if it creates value for owners (if it earns more than it costs)

What is the main idea of IRR?

Take on project if its return is higher than the required rate of return

What is an example of a sunk cost?

Test marketing expenses

A benchmark PE ratio can be determined using:

the PEs of similar companies; a company's own historical PEs

Opportunity costs are classified as _______ cost in project analysis

Relevant

NPV and I are are usually generate the _______ except/reject decision for a single project

Same

The AAR is calculated by taking the average net income and dividing it by the average ________ value.

Book

OCF is calculated as net income plus depreciation using the _______ approach

Bottom-up

DDM: Stocks:

- No maturity rate / unlimited life - Dividends are paid in perpetuity and tend to grow at some growth rate g

Market order is?

- You agree to trade at the current quote/price - Order executes at current quote/price

Limit order is?

- You stipulate a limit price - Will not execute until price goes above/below limit price

According to the average accounting return rule, a project is acceptable if it's average accounting return exceeds:

A target average accounting return

If Payback < Cutoff

Accept project

IRR: Discount rate that makes NPV =

0

What are the two ways to value stock/equity?

1) Cash flows / Dividend discount models (DDMs) 2) P/E valuation (Multiples model)

Payback: What is the two-step process?

1. Estimate CFs 2. Calculate Payback - Subtract CFs from cost until it has been recovered

Discounted Payback: What is the 2-step process?

1. Estimate CFs 2. Calculate discounted payback: Subtract discounted CFs from cost until it has been recovered

Internal Rate of Return: What is the two step process?

1. Estimate CFs (including costs) 2. Calculate IRR

Net Present Value: What is the 3-step process?

1. Estimate CFs (including costs) 2. Estimate required rate of return 3. Calculate NPV

Arrange the steps involved in the discount payback period in order starting with the first step: A) Add the discounted cash flows B) Accept if the discounted payback period is less than some pre-specified number of years C) Discount the cash flows using the discount rate

C, A, B

IRR: Discount rate that equates ______ with the cost

CFs

What is the one exception to make in NPV and IRR disagree?

CFs change signs more than once (non-conventional cash flows)

What we traditionally think of as stock is a much larger asset class?

Common Stock

The _______ step is to determine whether cash flows are relevant.

First

What is Pro Forma?

Forward looking

If your order does not execute......

Gets in line based on price and time priority

What does the Non-Constant Growth Model assume?

Growth will eventually become constant

What does IRR stand for?

Internal Rate of Return

If g is not constant, use the ___________________.

Non-Constant Growth Model

What is the equation for estimating operating cashflows using the tax shield approach?

OCF = (Sales - Costs) x (1 - Tax Rate) + Depreciation x Tax rate

What is the equation for estimating operating cash flows using the top-down approach

OCF = Sales - Costs - Taxes

Which of the following are reasons it is 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 - All bond and stock flows are guaranteed to be paid - The life of common stock is essentially forever

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

When evaluating cost cutting proposals how are operating cash flows affected? - Wages are always reduced and cost cutting endeavors - There is an additional depreciation deduction - The decrease in costs decreases operating income - The decrease in costs increases operating income

There is an additional depreciation deduction; The decrease in costs increases operating income

True or False: Cash flows should always be considered on an aftertax basis

True

True or False: When developing cash flows for capital budgeting it is easy to overlook important items

True

The Non-Constant Growth Model is also known as?

Two-Stage Growth Model

What is the stand alone principal?

Use any and all changes in the firm's future cash flows that are a direct consequence of taking on the project

Korporate Classics Corporation won a bid to supply widgets to Pacer Corporation but lost money on the deal because they underbid the project. KCC fell victim to the __________

Winner's Curse

When analyzing a proposed investment we ______ include interest paid or any other financing costs

Won't

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

Zero

The rules for depreciating assets for tax purposes are based upon provisions in the

1986 Tax Reform Act

Cash flows should always be considered on a _______ basis

Aftertax

A person who bring buyers and sellers together is called a __________.

Broker

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

Budgeting

Which of the following are expected cash flows to investors in stocks? - Fees - Interest - Capital Gains - Dividends

Capital Gains; Dividends

Which of the following are weaknesses of the payback method? - All cash flows are included in the payback period - Cash flows received after the payback period is ignored - The cutoff date is arbitrary - Time value of money principles are ignored

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

Which kind of stock has a higher risk?

Common Stock

Which kind of stock has higher L/T average returns?

Common Stock

Which kind of stock has voting rights?

Common Stock

NASDAQ has which of these features: - Physical Trading Floor - Single DMM System - Computer Network of Securities Dealers - Multiple Market Maker System

Computer Network of Securities Dealers; Multiple Market Maker System

If g≠0 but g is constant, use the _________________.

Constant Growth Rate Model

Which of the following are fixed costs: - Cost of equipment - Inventory costs - Rent on a production facility - Net working capital

Cost of equipment; Rent on a production facility

Investment in networking capital arises when: - Equipment is purchased using long-term debt - Credit sales are made - Cash is kept for unexpected expenditures - Inventory is purchased

Credit sales are made; Cash is kept for unexpected expenditures; Inventory is purchased

What is networking capital?

Current assets minus current liabilities

Someone who maintains an inventory of stocks and buys and sells those stocks is known as a _________.

Dealer

Operating cash flow is a function of: - Initial investment in equipment - Depreciation - Salvage value of equipment - Earnings before interest and taxes - Taxes

Depreciation; Earnings before interest and taxes; Taxes

What are the advantages of the payback period method for management? - The payback period adjusts for the discount rate - It allows lower level managers to make small decisions effectively - 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; The payback period method is ideal for short projects; The payback period method is easy to use

While making capital budgeting decisions which of the following sentence is true regarding the initial investment of net working capital? - It is not at all considered while making capital budgeting decisions - It is treated as cash outflow at the end of the projects life - It is treated as sunk cost which will not be recovered - It is expected to be recovered by the end of the projects life

It is expected to be recovered by the end of the projects life

IRR > R means what?

It is value creating accept project

Unexecuted limit orders create what?

LOB

Market orders enter _____ and execute against ______ order with the best price.

LOB; limit

What is the main idea of the payback method?

Length of time a project takes to recover its initial investment/cost

What is the main idea of discounted payback?

Length of time discounted CFs take to recover its initial investment/cost

The computation of equivalent annual costs is useful when comparing projects with unequal

Lives

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

MIRR; NPV

In modern stock exchanges computer matching mechanism are used to?

Match buyers and sellers

What is the best decision rule to make capital budgeting decisions?

NPV

What are the three ways to make capital budgeting decisions?

NPV, IRR, Payback

By ignoring time value, the payback period rule May incorrectly accept projects with a __________ NPV

Negative

What does in NPV stand for?

Net Present Value

Accounts receivable and accounts payable are not an issue with project cash flow estimation unless changes in ____________ are overlooked.

Net working capital

NYSE stands for what?

New York Stock Exchange

The oldest and most recognized exchange?

New York Stock Exchange

What are examples of the stand alone principal?

New revenue, new costs, side effects, changes in networking capital, financing costs, taxes

Which of the following occurs in the primary market?

Newly-issued stocks are initially sold

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

One vote per share hold

The formula for valuing a constant growth stock is _______.

P0 = D1/(R-g)

Ignores time value of money, choosing cut off, ignore CF's past cut off date, biased against long-term projects, might reject value creating projects are problems with what?

Payback

The _________ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment.

Payback

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively

Payback Method

Preferred stock has preference over common stock in the __________. - Payment of dividends - Distribution of Corporate Assets - Portfolios of Individual Investors - Number of Votes Given

Payment of dividends; Distribution of corporate assets

A stock with dividend priority over common stock is called a _______ stock.

Preferred

Which kind of stock has a better claim to assets and profits?

Preferred Stock

Which kind of stock has fixed dividends?

Preferred Stock

Which kind of stock has higher dividends?

Preferred Stock

When a firm finances new investments it may set up accounts payable with suppliers but the balance at the firm must supply is called the investment and net _________ capital

Working

If g=0, use the ____________.

Zero Growth Rate Model P0 = D/R