Finance Exam 2
A project's average net income divided by its average book value is referred to as the project's average: a) Net present value b) Internal rate of return c) Accounting return d) Profitability index e) Payback period
Accounting Return
When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: a) Accepted because the payback period is less than the required time period. b) Accepted because the profitability index is greater than 1 c) Accepted because the profitability index is negative d) Rejected because the internal rate of return is negative e) Rejected because the net present value is positive.
Accepted because the profitability index is greater than 1.
Bonds are issued by the U.S. government: a) Are considered to be free of interest rate risk b) Generally have high coupons than comparable bonds issued by a corporation. c) Are considered to be free of default risk. d) Pay interest that is exempt from federal income taxes. e) Are called "munis"
Are considered to be free of default risk.
A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called the: a) Dirty price. b) Redemption value c) Call premium d) Original-issue discount e) Redemption discount
Call premium
Changes in the net working capital requirements: a) Can affect the cash flows of a project every year of the projects life. b) Only affect the initial cash flows of a project c) Only affect the initial and final cash flows of a project d) Are generally excluded from project analysis due to their irrelevance to the total project. e) Are excluded from the analysis as long as they are recovered when the project ends.
Can affect the cash flows of a project every year of the projects life.
The standard deviation of a portfolio: a) Is weighted average of the standard deviations of the individual securities held in the portfolio. b) Can never be less than the standard deviation of the most risky security in the portfolio. c) Must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. d) is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. e) Can be less than the standard deviation of the least risky security in the portfolio.
Can be less than the standard deviation of the least risky security in the portfolio.
Which one of the following is the rate at which a stock's price is expected to appreciate? a) current yield b) Total return c) Dividend yield d) Capital gain yield e) Coupon rate
Capital gain yield
Rossiter Restaurants is analyzing a project that requires $180,000 of fixed assets. When the project ends, those assets are expected to have an aftertax salvage value of $45,000. How is the $45,000 salvage value handled when computing the net present value of the project? a) Reduction in the cash outflow at time zero b) Cash inflow in the final year of the project c) Cash inflow for the year following the final year of the project d) Cash inflow prorated over the life of the project e) Not included in the net present value
Cash inflow in the final year of the project.
The cost of capital for a new project: a) is determined by the overall risk level of the firm b) is dependent upon the source of the funds obtained to fund that project. c) is dependent upon the firms overall capital structure. d) should be applied as the discount rate for all other projects considered by the firm. e) Depends upon how the fund raised for that project are going to be spend.
Depends upon how the fund raised for that project are going to be spend.
The internal rate of return is defined as the: a) Maximum rate of return a firm expects to earn on a project. b) Rate of return a project will generate if the project in financed solely with internal funds. c) Discount rate that equates the net cash inflows of a project to zero. d) Discount rate which causes the net present value of a project to equal zero e) Discount rate that causes the profitability index for a project to equal zero.
Discount rate which causes the net present value of a project to equal zero.
The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the: a) Net present value period b) Internal return period c) Payback period d) Discounted Profitability period e) Discounted payback period
Discounted payback period
What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate? a) Zero growth b) Dividend growth c) Capital pricing d) Earnings capitalization e) Coupon rate
Dividend growth
What are the distributions of either cash or stock to shareholders by a corporation called? a) Coupon payments b) Retained earnings c) Dividends d) Capital payments e) Diluted profits
Dividends
A bond's coupon rate is equal to the annual interest divided by which one of the following? a) Call price b) Current price c) Face value d) Clean price e) Dirty price
Face Value
A zero coupon bond: a) is sold at a large premium b) Pays interest that is tax deductible to the issuer at the time of payment. c) Can only be issued by the U.S. Treasury d) Has more interest rate risk than a comparable coupon e) Provides no taxable income to the bondholder until the bond matures.
Has more interest rate risk than a comparable coupon bond.
Callable bonds generally: a) Grants the bondholder the option to call the bond anytime after the deferment period. b) Are callable at par as soon as the call-protection period ends. c) Are called when market interest rates increase d) Are called within the first three years after issuance. e) Having a sinking fund provision.
Have a sinking fund provision.
Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project? a)Storing supplies in the same space currently used for materials storage. b) Utilizing the basket manager to oversee wreath production c) Hiring additional employees to handle the increased workload should the firm accept the wreath project d) Researching the market to determine if wreath sales might be profitable before deciding to proceed e) Planning on lower interest expense by assuming the proceeds of the wreath sales will be used to reduce the firm's currently outstanding balance
Hiring additional employees to handle the increased workload should the firm accept the wreath project.
Which one of the following will decrease the net present value of a project? a) Increasing the value of each of the project's discounted cash inflows b) moving each of the cash inflows forward to a sooner time period. c) Decreasing the required discount rate d) Increasing the project's initial cost at time zero e) Increasing the amount of the final cash inflow
Increasing the projects initial cost at time zero
The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's: a) Incremental cash flows b) Internal cash flows c) External cash flows d) Erosion effects e) Financing cash flows
Incremental cash flows.
All of the following are related to the proposed project. Which one of the these should be included in the cash flow at Time 0? a) Loan obtained to finance the project b) Initial investment in inventory to support the project c) Annual depreciation tax shield d) Aftertax salvage value e) Net working capital recovery
Initial investment in inventory to support the project.
A company's weighted average cost of capital: a) is equivalent to the aftertax cost of the outstanding liabilities. b) should be used as the required return when analyzing any new project. c) Is the return investors require on the total assets of the firm d) Remains constant when the debt-equity ratio changes. e) is unaffected by changes in corporate tax rates.
Is the return investors require on the total assets of the firm
Why is payback often used as the sole method of analyzing a proposed small project? a) Payback considers the time value of money b) All relevant cash flows are included in the payback analysis. c) It is the only method where the benefits of the analysis outweigh the costs of that analysis. d) Payback is the most desirable of the various financial methods of analysis e) Payback is focused on the long-term impact of a project.
It is the only method where the benefits of the analysis outweigh the costs of that analysis.
The secondary market is best defined by which one of the following? a) Market in which subordinated shares are issued and resold b) Market conducted sole by brokers c) Market dominated by dealers d) Market where outstanding shares of stock are resold e) Market where warrants are offered and sold.
Market where outstanding shares of stock are resold.
If a stock portfolio is well diversified, then the portfolio variance: a) Will equal the variance of the most volatile stock in the profile b) May be less than the variance of the least risky stock in the portfolio c) Must be equal to or greater than the variance of the least risky stock in the portfolio. d) Will be a weighted average of the variances of the individual securities in the portfolio. e) Will be an arithmetic average of the variances of the individual securities in the portfolio.
May be less than the variance of the least risky stock in the portfolio
Assigning discount rates to individual projects based on the risk level of each project: a) may cause the company's overall weighted average cost of capital to either increase or decrease over time. b) Will prevent the company overall cost of capital form changing over time c) Will cause the company overall cost of capital to decrease over time d) decreases the value of the company over time e) Negates the company goal of creating the most value for its shareholders.
May cause the company's overall weighted average cost of capital to either increase or decrease over time
If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be: a) Independent b) Interdependent c) Mutually exclusive d) Economically scaled e) Operationally distinct
Mutually Exclusive
A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called? a) Net present value b) Internal return c) Payback value d) Profitability index e) Discounted payback
Net present value
Last year, Lexington Homes issued $1 million in unsecured, noncallable debt. This debt pays an annual interest payment of $55 and matures six years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt? a) Semiannual coupon b) Discount bond c) Note d) Trust deed e) Collateralized
Note
The option that is forgone so that an asset can be utilized by a specific project is referred to as which one of the following? a) Salvage value b) Wasted value c) Sunk cost d) Opportunity cost e) Erosion
Opportunity cost
A securities market primarily composed of dealers who buy and sell for their own inventories is referred to which type of market? a) Auction b) Private c) Over-the-counter d) Regional e) Insider
Over-the-counter
The length of time a firm must wait to recoup the money it has invested in a project is called the: a) Internal return period b) Payback period c) Profitability period d) Discounted cash period e) Valuation period
Payback period
Constant Dividend equation
Po= Do ______ i/y
Which one of the following is a type of equity security that has a fixed dividend and a priority status over other equity securities? a) Senior bond b) Debenture c) Warrant d) Common stock e) Preferred stock
Preferred stock
A deferred call provision in which one of the following? a) Requirement that a bond issuer pay the current market price, plus accrued interest, should the firm decided to call a bond. b) Ability of a bond issuer to delay repaying a bond until after the maturity date should the issuer so opt. c) Prohibition placed on an issuers from redeeming callable bonds prior to a specified date. d) Prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date. e) Requirement that a bond issuer pay a call premium that is equal to or greater than one year's coupon should that issuer decide to call a bond.
Prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date.
The dividend growth model: a) Only values stocks at time 0 b) Cannot be used to value constant dividend stocks c) Can be used to value both dividend-paying and non-dividend-paying stocks. d) Requires the growth rate to be less than the required return. e) Assumes dividends increase at a decreasing rate
Requires the growth rate to be less than the required return.
Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? a) Reward-to-risk matrix b) Portfolio weight graph c) Normal distribution d) Security market line e) Market real returns.
Security market line
Which one of the following best illustrates erosion as it related to a hot dog stand located on the beach? a) Providing both ketchup and mustard for customers use. b) Repairing the roof of the hot dog stand because of water damage. c) Selling fewer hot dogs because hamburgers were added to the menu d) Offering french fries but not onion rings e) Losing sales due to bad weather
Selling fewer hot dogs because hamburgers were added to the menu
The principle of diversification tells us that: a) Concentrating an investment in two or three large stocks will eliminate al of the unsystematic risk. b) Concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. c) Spreading an investment across five diverse companies will not lower the total risk. d) Spreading an investment across many diverse assets will eliminate all the systematic risk. e) Spreading an investment across many diverse assets will eliminate some of the total risk. f) Price-earning ratio
Spreading an investment across many diverse assets will eliminate some of the total risk.
The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles? a) Underlying value principle b) Stand-alone principle c) Equivalent cost principle d) Salvage principle e) Fundamental principle
Stand-alone Principle
G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost? a) Opportunity b) Fixed c) Incremental d) Erosion e) Sunk
Sunk
The yield on a corporate bond differ from those on a comparable treasury security primarily because of: a) Interest rate risk and taxes b) Taxes and default risk c) Default and interest rate risks d) Liquidity and inflation rate risk e) Default, inflation, and interest rate risks.
Taxes and default risk
The depreciation tax shield is best defined as the: a) Amount of tax that is saved when an asset is purchased. b) Tax that is avoided when an asset is sold as salvage c) Amount of tax that is due when an asset is sold d) Amount of tax that is saved because of the depreciation expense e) Amount by which the after-tax depreciation expense lowers net income.
The amount of tax that is saved because of the depreciation expense
Which one of the following best describes the concept of erosion? a) Expenses that have already been incurred and cannot be recovered. b) Change in net working capital related to implementing a new project c) The cash flows of a new project that come at the expense of a firm's existing cash flows. d) The alternative that is forfeited when a fixed asset is utilized by a project e) The differences in a firm's cash flows with and without a particular project.
The cash flows of a new project that comes at the expense of a firm's existing cash flows.
Which one of these is a negative covenant that might be found in a bond indenture? a) The company shall maintain a current ratio of 1:1 or higher b) The company cannot lease any major assets without bondholder approval c) The company must maintain the loan collateral in good working order. d) The company shall provide audited financial statements in a timely manner. e) The company shall maintain a cash surplus of $100,000 at all times.
The company cannot lease any major assets without bondholder approval.
If a project has a net present value equal to zero, then: a) The total of the cash inflows must equal the initial cost of the project b) The project earns a return exactly equal to the discount rate c) A decrease in the project's initial cost will cause the project to have a negative NPV d) Any delay in receiving the projected cash inflows will cause the project to have a positive NPV. e) The project's PI must also be equal to zero.
The project earns a return exactly equal to the discount rate
A project has a net present value of zero. Which one of the following best describes this project? a) The project has zero percent rate of return b) The project requires no initial cash investment c) The project has no cash flows d) The summation of all the project's cash flows is zero e) The project's cash inflows equal its cash outflows in current dollar teams.
The projects cash inflows equal its cash outflows in the current dollar teams.
The primary advantage of using the dividend growth model to estimate a company's cost of equity is: a) the ability to apply either current or future taxes b) the models applicability to all corporations c) is the models consideration of risk d) the stability of the computed cost of the equity over time. e) the simplicity of the model
The simplicity of the model
Winston Co. has a dividend-paying stock with a total return for the year of -6.5percent. Which one of the following must be true? a) The dividend must be constant b) The stock has a negative capital gains yield c) The dividend yield must be zero d) The required rate of return for this stock increased over the year. e) The firm is experiencing supernormal growth
The stock has a negative capital gains yield.
Standard deviation measures which type of risk? a) Total b) Non diversifiable c) Unsystematic d) Systematic e) Economic
Total
The bond market requires a return of 9.8 percent on the five-year bonds issued by JW Industries. The 9.8 percent is referred to as which one of the following? a) Coupon rate b) Face rate c) Call rate d) Yield to maturity e) Current Yield
Yield to maturity
A bond that has only one payment, which occurs at maturity, defines which one of these types of bonds? a) Debenture b) Callable c) Floating-rate d) Junk e) Zero coupon
Zero coupon
A company's current cost of capital is based on: a) only the return required by the company's current shareholders b) The current market rate of return on equity shares. c) the weighted cost of all future funding sources d) both the returns currently required by its debt holders and stockholders. e) the company's original debt-equity ratio.
both the returns currently required by its debt holders and stockholders.
The dividend growth model: a) is only as reliable as the estimated growth b) Can only be used if historical dividend information is available. c) considers the risk that future dividends may vary from their estimated values d) applies only when a company is currently paying dividends e) is based solely on historical dividend information
is only as reliable as the estimated growth
