FIN 325 T/F
As CFO of your firm, you would like to hear that Wall Street analysts believe that your firm's stock should be valued using a lower Beta and that your bond's should trade at a lower yield-to-maturity.
T
The relationship between nominal interest rates and real interest rates is given by: (1 + R) = (1 + r)(1+inflation rate), where R is the nominal rate of interest and r is the real rate of interest.
T
The returns on Stock A and Stock B are positively correlated. It must therefore be true that they have positive covariance.
T
The small-firm effect is cited as evidence against market efficiency.
T
The standard deviation is the square root of the variance
T
The weak form of the efficient market theory implies that analysts employing technical analysis will not achieve consistently superior investment returns.
T
To compute WACC, one should not use accounting values for debt (D) and equity (E). Instead, one should use the market values of D and E.
T
We mentioned that combustion- turbine ( CT) generators can be set up to burn either oil or natural gas. Consider how the value of this option will be affected by the correlation between oil and natural gas prices. If oil and natural gas prices are highly, positively correlated, then this option will go down in value.
T
While the variance and the standard deviation are the most common measures of risk, they do not differentiate between upside and downside risk.
T
You are senior interviewing for a job (you are a guy) and you need to buy a suit. You buy a 2nd pair of pants with your new suit. The cost of the 2nd pair of pants is basically the cost of a put option on the first pair of pants.
T
You buy a "forever stamp" from the US Postal Service. This stamp is a real option, essentially a call option on 1st class mail service.
T
You buy a bigger office building than you think your firm will need. The cost of the extra, unused space is the cost of a real option, essentially an expansion option.
T
An option holder is not entitled to any dividends paid on the underlying stock.
T
The following event, from the corporation's standpoint, will represent an increase in cash flow: reduction in short-term loans
F
The pecking order theory implies that firms prefer external to internal financing.
F
The three main bond rating agencies are Moody's, Standard & Poor's, and A.M Best.
F
The weak form of the efficient market theory implies that analysts employing technical analysis will consistently achieve superior investment returns.
F
Two bonds have exactly the same YTM, maturity, and Face Value. But Bond A has a higher coupon rate than Bond B. Bond A will have a longer duration than Bond B.
F
The following event, from the corporation's standpoint, will represent an increase in cash flow: increase in dividends paid
F
The following event, from the corporation's standpoint, will represent an increase in cash flow: increase in inventory
F
"Economic Dilution" occurs whenever new shares are issued. Furthermore, the term "economic dilution" is as popular as NCAA basketball.
F
A good example of a credible economic signal is a firm that claims, in both its annual report as well as in its employment literature, that "people are our most important asset."
F
A short-seller hopes that the stock he borrowed goes up in price while he's borrowed it.
F
According to Miller and Modigliani's dividend irrelevance theory, an increase in dividends is a more effective way to compensate shareholders as opposed to an increase in stock repurchases. This is true provided that financial markets are efficient and there are no taxes.
F
According to the assigned article "Investors to Big Oil: Make it Rain," which was discussed in class, some large oil companies have undertaken acquisition of smaller firms in order to maintain their high dividend payout ratios and high share repurchase programs.
F
Accrued wages increase by $5,000. All else equal, this represents a decrease in the corporation's cash flow.
F
Alpha measures the marginal contribution of a stock to the risk of a well-diversified portfolio.
F
As CFO of your firm, you would like to hear that Wall Street analysts believe that your firm's stock should be valued using a higher Beta and that your bonds should trade at a higher yield-to-maturity.
F
Consider a two-stock portfolio (for two very different stocks), displayed on a risk-return diagram. As long as the correlation coefficient for the returns does not equal either -1.0 or 1.0, the frontier connecting these two stocks will always consist of straight lines.
F
Consider an American call option on a stock that pays no dividends. It occasionally makes sense to exercise this type of option before its expiration.
F
Consider an all-equity firm with no taxes. As earnings before interest and taxes (EBIT) increase, the earnings per share (EPS) also increase, but at a faster rate than EBIT.
F
Consider homeowners who have financed their homes with long-term fixed rate mortgages. If actual inflation is greater than expected inflation, then--considering only their mortgages--homeowners will be worse off due to their paying of a higher real interest rate.
F
Consider homeowners who have financed their homes with long-term fixed rate mortgages. If actual inflation is less than expected inflation, then--considering only their mortgages--homeowners will be better off due to their paying of a lower real interest rate.
F
Consider the issue of survivorship bias and mutual fund manager performance. The existence of survivorship bias implies that the average returns of the current set of mutual fund managers is probably understated.
F
Consider the valuation of your Beacon simulation team. If you compute a CAPM equity beta that is unreasonably high, then: i) your expected return on equity will be too high, and ii) your weighted average cost of capital will be too high, and iii) your firm's enterprise valuation calculation will be too high.
F
Consider the valuation of your Beacon simulation team. If you compute a CAPM equity beta that is unreasonably low, then: i) your expected return on equity will be too low, and ii) your weighted average cost of capital will be too low, and iii) your firm's enterprise valuation calculation will be too low.
F
Consider two call options on two stocks, Stock A and Stock B. Stock A and Stock B currently have the same stock price. The two options have the same exercise price and time to maturity. Stock A has a higher CAPM Beta than Stock B, therefore the call option on Stock A must be more valuable than the call option on Stock B.
F
Consider two call options on two stocks, Stock D and Stock C. Stock C and Stock D currently have the same stock price. The two options have the same exercise price and time to maturity. Stock D has a higher CAPM Beta than Stock C, therefore the call option on Stock C must be less valuable than the call option on Stock D.
F
Consider two fixed-rate mortgages, Mortgage A and Mortgage B. Both are interest-only mortgages at an interest rate of 6% APR with monthly payments. The only difference is that mortgage A has a 25-year maturity while mortgage b has a 30-year maturity. Therefore, the monthly payment on mortgage A must be greater than the monthly payment on mortgage B.
F
Consider two mutually exclusive capital budgeting alternatives, Project A and Project B, both with positive NPV's. However, Project A has higher NPV while Project B has a higher IRR. If these are normal investment projects (a single cash outflow occurs first) then the IRR of the incremental project "A - B" will be less than the cost of capital.
F
Diversification over a large number of assets completely eliminates risk.
F
During the summer of 2019, certain Treasury bond yields have "inverted." That means that the yield on some longer-term bonds was lower than the yield on equivalent shorter-term bonds. As of 8/30/2019, the U.S. 10-year Treasury Note yielded 1.51% while the 1-year U.S. Treasury Note yielded 1.76%. According to the Expectations Hypothesis, as of 8/30/2019, investors are expecting short-term interest rates to increase in the future.
F
Empirical research, discussed in class, supports the idea that the announcement of an unexpected dividend increase leads to an increase in a firm's stock price. Likewise, the announcement of an unexpected dividend decrease leads to a decrease in a firm's stock price. Further, the magnitudes of these two effects are approximately the same.
F
Firm C produces machine tools (e.g. tools purchased by a manufacturing firm). Firm D produces breakfast cereal. Firm D is more likely to have the higher cost of capital.
F
For an abandonment option, the option value increases as the underlying uncertainty decreases.
F
For high-yield bonds, the expected return on such a bond is generally very close (e.g. within 25 basis points) to the promised yield.
F
Generally high growth stocks pay high, steadily growing dividends.
F
Historically speaking in the U.S., small capitalization stocks have underperformed large capitalization stocks. Also, high book-to-market stocks have underperformed low book-to-market stocks.
F
Historically, the market risk premium has been generally higher than the expected return on the market
F
I agree with the following statement: If the yield on a bond increases—all else equal--then so will its price.
F
If an asset's return is riskless and never deviates from its mean, then both its variance and standard deviation equals one.
F
In general in the U.S., a firm's expected return on assets is less than its (after-tax) WACC.
F
Investors are mainly averse to those risks that can be eliminated through diversification.
F
Investors are mainly concerned with those risks that can be eliminated through diversification.
F
Jillian owns a large number of American options (that trade on the CBOE) which give her the right to purchase shares of WAN stock at a price of $20 a share over the next month. Currently, WAN stock is selling for $24.50. Jillian would like to profit on her holding of the WAN options right now because she is concerned that WAN's stock price may fall in the next month. Jillian's best course of action is to exercise her options now and earn a payoff of $4.50 per option.
F
Microsoft announced (Fall 2019) that it would start a $40b share repurchase program. This announcement is evidence, regarding the dividend payout controversy, that its management is in favor of the "rightist" approach on the payment of dividends.
F
Projects with high fixed costs have lower break-even points.
F
Shareholders of XYZ, Inc. are expecting to receive a $3 dividend. The stock is currently trading at $200 per share. Once the stock begins trading ex-dividend, one would expect the share price of XYZ--all else equal--to fall by more than $3.
F
Shareholders of XYZ, Inc. are expecting to receive a $3 dividend. The stock is currently trading at $200 per share. XYZ declares a $3/share dividend. Once the stock begins trading ex-dividend, one would expect the share price of XYZ--all else equal--to fall by more than $3.
F
Since the expected rate of return on debt is less than the expected rate of return on equity, the weighted average cost of capital declines as more debt is issued and exchanged for equity. (Assume no taxes or transaction costs.)
F
Suppose a firm uses the same cost of capital to evaluate all projects. It will tend to underestimate the NPV of high-risk projects.
F
Suppose that short-term U.S. Treasury Bills are truly risk-free. If so, that means that the correlation of the returns on any asset with the returns on the T-Bill will be greater than zero.
F
Suppose you are calculating Free Cash Flow. To account for depreciation, one should subtract depreciation expense from operating income.
F
Suppose you are performing an NPV analysis on a project with very uncertain future cash flows that you think are overly optimistic. Your textbook authors recommend that, in such a situation, you should compute NPV using a higher discount factor rather than adjusting the cash flows downward.
F
The company cost of capital is the correct discount rate for all projects undertaken by the company.
F
The concept of "Double taxation" refers to partnerships and LLCs but not to corporations.
F
The following event, from the corporation's standpoint, will represent an increase in cash flow: decrease in A/P (accounts payable)
F
The following event, from the corporation's standpoint, will represent an increase in cash flow: increase in A/R (accounts receivable)
F
We have followed the financial troubles of General Electric (GE) this semester (Fall 2018). The main reason GE has had trouble--and a corresponding deep reduction in its stock price-- is its decision to lower its quarterly dividend from $0.12 per share to $0.01 per share.
F
When a firm faces financial distress, bondholders can gain if shareholders make sufficiently risky investments, even if they have negative NPV. This increases the chances that creditors will be paid in full although it also increases the chances that shareholders will obtain a zero-payoff from holding the stock.
F
When calculating the (after-tax) WACC for a firm, one should employ the book values of the firm's debt and equity as opposed to its market values.
F
When performing capital budgeting analysis it is important to consider the dividends and interest payments associated with a given project.
F
While the variance and the standard deviation both measure the variability of the returns, the variance is easier to interpret because it is in the same units as the returns themselves
F
The relationship between nominal interest rates and real interest rates is given by: (1 + r) = (1 + R)(1+inflation rate), where R is the nominal rate of interest and r is the real rate of interest.
F; (1 + R) = (1 + r)(1+inflation rate)
The U.S. Federal Corporate Income Tax Rate is approximately 35%.
F; 21%
You are considering adding a microbrewery on to one of your firm's existing restaurants. This will entail an increase in inventory of $10,000, an increase in Accounts Payable of $4,500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is a decrease of $5,500.
F; Increase
Assume that inflation is positive (e.g. 2% per year) and suppose you see a car loan advertised at "12% APR with monthly payments." Economists would call the car loan's monthly rate of 1% a "real interest rate."
F; Nominal Rate
Money that a firm has already spent or committed to spend regardless of whether a project is taken is called an opportunity cost.
F; Sunk Cost
The discount rate that sets the current market price of the bond equal to the present value of the promised bond payments is called the zero-coupon yield.
F; Yield to Maturity Definition
For most stocks, a stock's price is based on the expected present value, at the market capitalization rate, of all the stock's future earnings.
F; Dividends
According to the assigned article "Investors to Big Oil: Make it Rain," which was discussed in class, some large oil companies have undertaken asset sales in order to maintain their high dividend payout ratios and high share repurchase programs.
T
A bond's coupon rate is useful for determining the cash flows generated by the bond. However, one does not use the coupon rate to discount the bond's cash flow.
T
A call option increases in value if the risk-free interest rate increases.
T
A decrease in Accounts Receivable or inventory--all else equal--will represent a decrease in these particular assets of the firm. Such a decrease results in a positive cash flow impact on the firm.
T
A firm increases its dividends $5,000. All else equal, this represents a decrease in the corporation's cash flow.
T
A rights offering consists of intentionally underpriced, newly-issued equity. However, the underpriced new equity is offered equally to all shareholders. This represents a fair deal to all shareholders.
T
A stock's price is based on the expected present value, at the market capitalization rate, of all the stock's future dividends
T
According to the Fortune magazine article "Why Your Stock Just Tanked," an individual analyst provided an outlandishly high EPS estimate to Thomson Financial that skewed the market concensus. Then, after the firm did not meet this concensus, the market news focused on the shortfall and punished the stock, dropping the stock price by 8% in the first half-hour after the opening bell.
T
According to your authors, use of the payback rule is clearly inferior to using either IRR or NPV.
T
As CFO, you are reviewing your purchasing manager's decision to purchase extended warranties on a small fleet of trucks. The particular brand of trucks your firm is purchasing is well-known for their extreme reliability. This extreme reliability, from a real options perspective, makes the extended warranty less valuable. The reason is that an extended warranty is essentially a put option and the extreme reliability represents a reduction in the volatility of the underlying asset.
T
As the number of stocks in a portfolio increases unique risk decreases and approaches zero.
T
Because investors dislike only negative resolutions of uncertainty, alternative measures that focus solely on downside risk have been developed, such as the semi-variance and the expected tail loss.
T
Because no assumption on the risk preferences of investors is necessary to calculate an option's price using either the Binomial Model or the Black-Scholes formula, the models must work for any set of risk preferences, including risk-neutral investors.
T
Both put and call options decrease in value if the stock's underlying volatility decreases.
T
Consider a firm that has a low debt ratio but takes on a small amount of additional debt. The equity owner's financial risk will increase even if the firm's default risk stays the same.
T
Consider a firm that has a very low debt ratio but takes on a small amount of additional debt. The equity owner's financial risk will increase even if the firm's default risk stays the same.
T
Consider a firm that underprices a SEO. The underpricing is a serious hidden cost that the firm is passing along to its existing shareholders.
T
Consider a two-stock portfolio (for two very different stocks), displayed on a risk-return diagram. Except for the cases when the correlation coefficient for the returns equals either -1.0 or 1.0, the frontier connecting these two stocks will always be curved.
T
Consider the New Heritage Doll Company case. The sum of revenue for the three individual divisions (Production, Retail, Licensing) exceeded the revenue of the entire corporation. However, the sum of the operating profit for these three divisions was the same as for the entire corporation.
T
Consider the variance formula on a 5-stock portfolio. Such a formula will have 5 variance terms and 20 covariance terms.
T
Consider two bonds, Bond A and Bond B, that both have a ten-year maturity from now and $1,000 face value. (Both bonds have the same risk and have the same yield of 3%.) They both pay a 4% coupon on an annual basis. Bond B pays an annual coupon (first payment occurs at t=1). Bond A, on the other hand, pays a semi-annual coupon of 4%/2 = 2% with the first semi-annual coupon occurring in 6 months. Bond A is worth more than Bond B.
T
Consider two bonds, Bond A and Bond B, that both have a ten-year maturity from now and $1,000 face value. (Both bonds have the same risk and have the same yield of 3%.) They both pay a 4% coupon on an annual basis. Bond B pays an annual coupon (first payment occurs at t=1). Bond A, on the other hand, pays a semi-annual coupon of 4%/2 = 2% with the first semi-annual coupon occurring in 6 months. Bond B is worth less than Bond A.
T
Depreciation expense will reduce taxable income
T
Depreciation is a non-cash expense
T
Discounting free cash flows at the (after-tax) WACC assumes that debt is rebalanced every period to maintain a constant ratio of debt to market value of the firm.
T
Firms with high operating leverage tend to have higher asset betas.
T
For an expansion option, the option value increases as the risk-free rate increases.
T
For most firms, market value is usually greater than book value.
T
Free cash flow (FCF) and net income (NI) differ in the following ways: I) Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated before interest. II) Net income is calculated after various noncash expenses, including depreciation; FCF adds back depreciation. III) Capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows.
T
Generally, a corporate bond has a higher promised yield than a government bond.
T
Higher financial leverage magnifies both good and bad results.
T
If a bond's yield to maturity is higher than its coupon rate, then the bond price will be lower than its face value. (Assume annual coupon payments.)
T
In a recent news article retired schoolteacher Jack Ennis is quoted as saying he had sold on Tuesday (Oct. 30, 2018) the roughly 8,000 GE shares he had held for decades, due to Gneral Electric's announcement to reduce its dividend payments to shareholders. "I made the decision upon learning this morning that the dividend was slashed from 12 cents to a token penny per share," he said. "I can't afford to commit a sum of money like that not earning a dividend." This statement by Mr. Ennis directly contradicts the Miller and Modigliani stance on the relevance of dividend payments.
T
In general, the market risk premium is the difference in expected return--that investors expect over the coming year--between the average stock and a risk-free security
T
In terms of analyzing capital budget methods, the payback method is inferior to the IRR method.
T
In terms of percentage price changes resulting from ratings changes, the downside from holding a corporate bond is much larger than the upside.
T
In the case of a growing perpetuity, the present value of the cash flow is given by: [C1/(r-g)] where r>g.
T
Investment grade bonds can usually be entered at face value on the books of banks and life insurance companies.
T
Investor A has a undiversified investment portfolio, owning only 2 stocks. Investor B has a diversified investment portfolio, owning 500 different stocks. All else equal, Investor A will care more about firm-specific risk, within her portfolio, compared to Investor B.
T
Investor A has a undiversified investment portfolio. Investor B has a diversified investment portfolio. All else equal, Investor A will care more about firm-specific risk, within her portfolio, compared to Investor B.
T
Investors demand higher expected rates of return from stocks with returns that are highly exposed to macroeconomic risks.
T
Longer duration bonds will, all else equal, have greater volatility than shorter duration bonds.
T
Modigliani and Miller Proposition I states that the market value of any firm is independent of its capital structure.
T
No form of the efficient market hypothesis (weak/semi-strong/strong) implies that technical analysis is valuable.
T
Owning a call option is a riskier investment than owning the underlying stock. This makes sense because replicating a call option consists of buying delta shares of the underlying stock and then engaging in borrowing, i.e. creating a leveraged position in the underlying stock.
T
Portfolios that offer the highest expected return for a given variance or standard deviation are known as efficient portfolios.
T
Project X has the following cash flows: C0= +2000, C1= -1,300 and C2= -1,500. There can be at most one IRR for this project.
T
Recently (Aug., 2018) bond investors have become less confident that firms in Turkey will be able to make bond payments coming due for the remainder of 2018. As a direct result of this news, one should expect an increase in the yields on Turkish corporate bonds.
T
Regardless of which depreciation schedule is used, the sum of all depreciation expenses--across all years within the schedule-- must equal 100%
T
Stock B has a greater standard deviation than stock A. Stock A has higher beta than stock B. All else equal, a well-diversified investor will prefer stock B.
T
Suppose a firm uses the same cost of capital to evaluate all projects. It will tend to underestimate the NPV of low-risk projects.
T
Suppose a project has an IRR that equals its cost of capital. Then, regardless of whether the project is a borrowing or a lending project, that project has zero NPV at that cost of capital.
T
Suppose that you believe strongly in the Efficient Markets Hypothesis and buy shares of XYZ, Inc. at $100 per share. Unfortunately, XYZ value falls to $90 per share, thus losing you $10 per share on your holdings. Given this fact, you would enthusiastically support hearing that XYZ issued new equity shares to new investors at a price of $93 per share.
T
Suppose the IRS determines that Ms. T. Potts should expense installation costs, rather than adding them to capital. In this case, the after-tax cost of the kiln, on a PV basis, will decrease.
T
Suppose you are performing an NPV analysis on a project with very uncertain future cash flows that you think are overly optimistic. Your textbook authors recommend that, in such a situation, you should avoid using a higher discount factor to calculate NPV rather than adjusting the cash flows downward.
T
Suppose you own a $1,000 face value bond that has a 6.5% (annual) coupon, has a five-year maturity, and a 7% yield. The below formula in Excel will properly calculate the value of the bond as of one year from now. =-PV(0.07,4,65,1000)
T
The 2018 corporate tax reform enabled the immediate expensing of capital projects. This is equivalent to a 100% depreciation rate in the first year.
T
The Black-Scholes Option Pricing Model can be derived from the Binomial Option Pricing Model by making the length of each period, and the movement of the stock price per period, shrink to zero and letting the number of periods grow infinitely large.
T
The State of California has changed labor laws during the past month (Sept. 2019) in an attempt to classify Uber and Lyft drivers as employees, rather than as independent contractors. Uber and Lyft must now decide whether they should shutdown operations in the State of California. The decision should depend on Uber and Lyft's estimates of future cash flows from continuing operations in California. Foregone cash flows from continuing operations would represent an opportunity cost of shutting down.
T
The capital raised by a firm, from all its stock offerings, equals the sum of legal capital plus additional paid-in capital.
T
The constant growth formula for stock valuation can work for firms with negative growth (declining) rates in dividends.
T
The duration of a zero-coupon bond will always be longer than the duration of a coupon bond having the same maturity.
T
The following event, from the corporation's standpoint, will represent an increase in cash flow: decrease in inventory
T
The following event, from the corporation's standpoint, will represent an increase in cash flow: increase in accrued wages
T
The formula for the present value of a perpetuity (PV= C_1 / (r - g)) requires that g < r. The economic reason that g must be less than r is that a perpetuity with g >= r would have infinite value and that makes no economic sense.
T
The market values of depreciable assets will generally be different from their accounting values
T
The new Trump administration is proposing the immediate expensing of capital projects. This is equivalent to a 100% depreciation rate in the first year.
T
The possibility that the winner (highest bidder) in an auction process may have bid a price that is very high (far above the value) is called "the winner's curse."
T
