FINA

The investment decision

invest in assets that earn a return greater than the minimum acceptable hurdle rate

mutual fund

investments that pool an investment with other investors to purchase a shares of collection stock

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth

In theory, a firm should maintain financial leverage consistent with a capital structure that

maximizes the owner's wealth

Financial institutions are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments.

true

Amazon and Walmart are examples of corporations because

they are controlled by managers acting as agents for shareholders who have limited liability

Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs

The discount rate that makes the present value of a bond's payments equal to its price is termed the

yield to maturity.

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital

False

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.

False

Shareholders are also known as the residual owners of the firm's cash flows - they only get paid after other stakeholders are content.

False

Suppose a project under consideration will earn returns equal to current investments but its expected returns are less certain (i.e., riskier). Financial managers would accept this project for investment.

False

Suppose you have an investment in a stock that had a negative 50% return (a loss) in the first year and a positive 50% return (a gain) in the second year. The geometric returns is 0%

False

The financing decision

Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations

Complete the following sentence. The WACC _________________

For a firm represents the risk and target capital structure of the firm's existing assets as a whole.

The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks

Have no diversification of risk

The shadow banking system has escaped regulation primarily because it does not accept traditional bank deposits. As a result, many of the shadow banking institutions have been able to employ higher market, credit and liquidity risks, and have higher capital requirements.

false

Financial markets are __________ in which suppliers of funds and demanders of funds can transact business directly.

forums

According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?

increase bank executive turnover

Generally, increases in leverage result in______________ return and _____________________ risk.

increased; increased

What are advantages of payback period?

- Does not require complex calculations - Measures Liquidity, Easy to communicate - Does not require discount rate

What are the advantages of the corporate form of business organization?

-Ease of raising additional funds -Easy transfer of ownership -Limited liability -Perpetual life

Once a firm decides to accept a project, then the financial manager must decide where to get the money to pay for the project. Funding for a project can be simplified from

-Equity -debt

Profit maximization may not lead to the highest possible share price because (check all correct)

-Profit maximization fails to account for risk - extremely profitable opportunities may be too risky. -Profits do not necessarily result in cash flows available to stockholders. There is a difference in accounting values and cash flows. -Timing is important—the receipt of funds sooner rather than later is preferred. Time is money!

Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as

-a means to ensure regulatory compliance -a balancing act that requires careful evaluation of the costs and benefits of each project

What types of analyses do the BNSF strategic studies team conduct?

-discounted cash flow -sensitivity

Identify which of these are the relevant cash flows when considering a capital budgeting project.

-lost rent from retail facility -remodeling expenses for new store -increase in inventory -expected salvage value of manufacturing equipment

In the formula r=D1P0+g, what does g represent?

the expected price appreciation yield from a common stock

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A decrease in the fixed costs

Limited liability means that owners of a business are not personally liable for all of its debts - owners can only lose the lessor of the value of their investment or $100,000

False

A corporation is contemplating an expansion project. The CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the corporation's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

Any opportunity costs associated with the project.

The benefits of portfolio diversification are highest when the individual securities have returns that

Are uncorrelated with the rest of the portfolio

Which component is more likely to be biased if book values are used in the calculation of WACC rather than market values?

Common stock

An advantage of organizing a firm as a corporation is that taxes are paid at the shareholder level.

False

By law, the board of directors makes decisions as a fiduciary on behalf of company executives

False

It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent

False

The dividend decision

If you can't find investments that make your minimum acceptable rate, return the cash to owners of your business

If the Federal Reserve took action to increase interest rates, a firm's cost of capital would Increase , ceteris paribus.

Increase

_________results from the use of fixed - cost assets or funds to magnify returns to a firm's owners

Leverage

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

Mutually Exclusive

The "gold standard" of investment criteria refers to:

NPV

The firm can be thought of as a ______________ of policies.

Nexus

The disadvantages of the IRR period method is that it

Requires complex calculations Requires a lot of data (estimates of all CFs) Only works for normal cash flows

The firm exists to create value for

Stakeholders

The degree of operating leverage has which of the following characteristics?

The DOL relates the change in sales to the change in net operating income

Which of the following statements is correct for a project with a negative NPV?

The cost of capital exceeds the IRR

Which of the following statements is correct?

The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales.

The capital market is where firms obtain external short term financing.

false

From investors' perspectives, the role of capital markets is to be an efficient market that allocates funds to their most productive uses.

True

In addition to voting, shareholders also have a claim on the firm's assets, after all debts have been paid.

True

Shareholders get any assets or cash flows of the corporation that remain after all other debts have been paid.

True

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

True

The board makes decisions concerning the hiring and firing of personnel, dividend policies and payouts, and executive compensation.

True

The main vote that shareholders have is to elect the Board of Directors

True

The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

The separation of ownership (shareholders) and control (managers) in larger corporations with many shareholders can lead to conflicts of interest between managers and owners.

True

Macro events only are reflected in the performance of the market portfolio because

Unique risks have been diversified away

The variance of an investment's returns is a measure of the:

Volatility of the rates of return

You are considering investing in a firm The dividend on the company's stock has not changed in the past ten years and most likely will not change in the foreseeable future. In this case, the most appropriate stock valuation model would be the _________ model.

Zero Growth

Index Fund

a type of mutual fund with a portfolio constructed to match or track the components of a market index

What is the hurdle rate?

cost of financing

A stock's ______ is found by dividing the stock's annual dividend by its closing price.

current yield

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

deemphasizing that variable as a critical factor.

What types of projects does the BNSF strategic studies team evaluate?

discretionary

Common stock can be valued using the perpetuity formula if the

dividends are not expected to grow

Investment banks make loans that individuals and businesses use to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to bank

false

Profit maximization may not lead to the highest possible share price for at least three reasons They are,

profits not always available to shareholders, timing, risk

List steps of the capital budgeting process Step 1 Step 2 Step 3 Step 4 Step 5

proposal Generation Review and analysis Decision Making Implementation Follow up

The difference between ... and ... is referred to as Net Working Capital

short term assets/short-term liabilities