Finance Final Quizzes
Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity? a. 9.77 percent b. 7.91 percent c. 9.24 percent d. 7.83 percent e. 7.54 percent
7.83 percent
Which one of the following statements is correct? a. The IRS automatically approves acquisitions that are primarily designed to lower federal taxes. b. The leverage associated with an acquisition increases the tax liability of the acquiring firm. c. A firm may benefit from an acquisition if it can lower its capital requirements. d. Firms can always benefit from economies of scale if they increase the size of their firm through acquisitions. e. If a firm uses its surplus cash to acquire another firm, then the shareholders of the acquiring firm immediately incur a tax liability related to the transaction.
A firm may benefit from an acquisition if it can lower its capital requirements
Assume you are an overconfident manager. You are most apt to do which one of the following more so than you would if you were not overconfident? a. Research a project more thoroughly before committing funds to commence it b. Accept risky projects that turn out to be less profitable than you expected c. Wait until new technology proves its worth before incorporating it into your firm's operations d. Avoid mergers and acquisitions e. Invest excess company cash more conservatively than your peers at other firms
Accept risky projects that turn out to be less profitable than you expected
You recently overheard your boss telling someone that if he'd actually crunched some numbers and done some analysis instead of just going with his instincts, he never would have opened the new store in Centre City. Which one of the following caused your boss to make a bad decision? a. Regret aversion b. Endowment effect c. Money illusion d. Affect heuristic e. Representativeness heuristic
Affect heuristic
Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes. Select one: a. At the break-even point, there is no advantage to debt. b. The earnings per share will equal zero when EBIT is zero for a levered firm. c. The advantages of leverage are inversely related to the level of EBIT. d. The use of leverage at any level of EBIT increases the EPS. e. EPS are more sensitive to changes in EBIT when a firm is unlevered.
At the break-even point, there is no advantage to debt
You are a hard-charging manager who doesn't really like to sit at a desk for too long. You prefer to gather information quickly, make a decision, and move on to the next item on your agenda. Which one of the following applies to you? a. Availability bias b. Arbitrage limits c. Law of small numbers d. Representativeness heuristic e. Regret aversion
Availability bias
Nadine made a business decision that turned out badly. In reflecting upon her decision, she decided it was a reasoning error that led to the faulty decision. Which one of the following areas of study best applies to this situation? a. Corporate ethics b. Financial statement analysis c. Managerial finance d. Debt management e. Behavioral finance
Behavioral finance
The tendency for a decision maker to search for reassurance that a recent decision he or she made was a good decision represents which one of the following characteristics? a. Overconfidence b. Overoptimism c. Affect heuristic d. Confirmation bias e. Representativeness heuristic
Confirmation bias
A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith Inc. What is the return that these individuals require on this investment called? Select one: a. Dividend yield b. Cost of equity c. Capital gains yield d. Cost of capital e. Income return
Cost of equity
Which one of the following is a marketed claim against the cash flows of a company? a. Tax payment to the IRS b. Dividend payment to shareholders c. Payment of employees' wages d. Payment for warranty work on a product produced by the company e. Payment of legal claim against the company
Dividend payment to shareholders
You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent? a. Arithmetic return b. Historical return c. Expected return d. Geometric return e. Required return
Expected return
You are the manager of a retail store. You believe the economy is in a recession and that sales for the month will be unusually slow. Since you have complete discretion over the pricing at your location, you decide to have a storewide sale and offer ten percent off all merchandise for a three-day period. You don't expect your superiors to criticize this decision as you believe they, along with the majority of the other store managers, feel the same way about the economy as you do. Which one of the following applies to you? a. Recency bias b. Law of small numbers c. Gambler's fallacy d. False consensus e. Money illusion
False consensus
Which one of the following is the equity risk related to capital structure policy? a. Market risk b. Systematic risk c. Static risk d. Business risk e. Financial risk
Financial risk
Consumer Marketing just conducted a two-phase survey. In the first phase, the survey questions were worded such that the answers tended to sound positive. In the second phase, the survey questions were reworded so the answers tended to convey a negative feeling. Both sets of survey questions should have resulted in similar results as the information solicited was essentially identical. However, the survey results varied significantly. This survey best illustrates which one of the following? a. Mental accounting b. Overconfidence c. Self-attribution bias d. Confirmation bias e. Frame dependence
Frame dependence
Which one of the following refers to the fact that an individual may reply differently if a question is asked in an equivalent but different manner? a. Loss aversion b. Gambler's fallacy c. Frame dependence d. Overconfidence e. Format reference
Frame dependence
Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights? a. Given the unequal weights of both the securities and the economic states, the standard deviation of the portfolio must equal that of the overall market b. The weights of the individual securities have no effect on the expected return of a portfolio when multiple states of the economy are involved c. Changing the probabilities of occurrence for the various economic states will not affect the expected standard deviation of the portfolio d. The standard deviation of the portfolio will be greater than the highest standard deviation of any single security in the portfolio given that the individual securities are well diversified e. Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of 0
Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of 0
A group of individual investors is in the process of acquiring all of the publicly traded shares of OM Outfitters. Once the shares are acquired, they will no longer be publicly traded. Which of the following terms applies to this process? a. Tender offer b. Proxy contest c. Going-private transaction d. Merger e. Consolidation
Going-private transaction
Which one of the following makes the capital structure of a company irrelevant? a. Taxes b. Interest tax shield c. 100 percent dividend payout ratio d. Debt-equity ratio that is greater than 0 but less than 1 e. Homemade leverage
Homemade leverage
The expected return on a portfolio considers which of the following factors? I. Percentage of the portfolio invested in each individual security II. Projected states of the economy III. The performance of each security given various economic states IV. Probability of occurrence for each state of the economy a. I and III only b. II and IV only c. I, III, and IV only d. II, III, and IV only e. I, II, III, and IV
I, II, III, and IV
The expected return on a portfolio: I. Can never exceed the expected return of the best performing security in the portfolio. II. Must be equal to or greater than the expected return of the worst performing security in the portfolio. III. Is independent of the unsystematic risks of the individual securities held in the portfolio. IV. Is independent of the allocation of the portfolio amongst individual securities. a. I and III only b. II and IV only c. I and II only d. I, II, and III only e. I, II, III, IV
I, II, and III only
Which one of the following statements is correct? a. The shareholders of an acquired firm are generally given a choice of accepting either cash or shares of stock when the acquisition is tax free. b. To be a tax-free acquisition, the shareholders of an acquired firm must receive shares in the acquiring firm that are equal to 25 percent or less of the value of the shares held in the acquired firm. c. The assets of an acquired firm are recorded on the books of the acquiring firm at their current book value regardless of the tax status of the acquisition. d. Target firm shareholders demand a higher selling price when an acquisition is a nontaxable event. e. If the assets of a firm are written up as part of the acquisition process, the increase in value is considered to be a taxable gain.
If the assets of a firm are written up as part of the acquisition process, the increase in value is considered to be a taxable gain
Westover Mills reduced its taxes last year by $210 by increasing its interest expense by $1,000. Which one of the following terms is used to describe this tax savings? a. Interest tax shield b. Interest credit c. Homemade leverage shield d. Current tax yield e. Tax-loss interest
Interest tax shield
Which of the following is an example of systematic risk? a. Investors panic causing security prices around the globe to fall precipitously b. A flood washes away a firm's warehouse c. A city imposes an additional one percent sales tax on all products d. A toymaker has to recall its top-selling toy e. Corn prices increase due to increased demand for alternative fuels
Investors panic causing security prices around the globe to fall precipitously
Firms A and B formally agree to each put up $25 million to create firm C. Firm C will perform environmental testing on the products produced by both Firm A and Firm B. Which one of the following terms describes Firm C? a. Joint venture b. Going-private transaction c. Conglomerate d. Subsidiary e. Leveraged buyout
Joint venture
The concept of homemade leverage is most associated with: a. M&M Proposition I with no tax. b. M&M Proposition II with no tax. c. M&M Proposition I with tax. d. M&M Proposition II with tax. e. the static theory proposition.
M&M Proposition I with no tax
Which one of the following states that the cost of equity capital is directly and proportionally related to capital structure? a. Static theory of capital structure b. M&M Proposition I c. M&M Proposition II d. Homemade leverage e. Pecking-order theory
M&M Proposition II
Phyllis is planning for her retirement in 15 years. She currently lives comfortably on $38,000 a year given that she is debt-free. Based on her family history she only expects to live ten years after she retires. Thus, she computes her retirement need as $38,000 a year for ten years. Which one of the following behaviors applies to Phyllis? a. Regret aversion b. Money illusion c. Self-attribution bias d. Endowment effect e. Myopic loss aversion
Money illusion
Over the past six months, you have watched as your parent's retirement savings have declined in value by 25 percent due to a severe financial market downturn. As a result, you have decided that you will never invest in stocks for your own retirement but will instead keep all of your money in an insured bank account. Which behavioral characteristic have you acquired as a result of the market downturn? a. Myopic loss aversion b. Get-evenitis c. Self-attribution bias d. Mental accounting e. Regret aversion
Myopic loss aversion
Which of the following is an example of unsystematic risk? a. An across the board increase in income taxes b. Adoption of a national sales tax c. Decrease in the national level of inflation d. An increased feeling of global prosperity e. National decrease in consumer spending on entertainment
National decrease in consumer spending on entertainment
Which of the following statements is correct? a. The unexpected return is always negative. b. The expected return minus the unexpected return is equal to the total return. c. Over time, the average return is equal to the unexpected return. d. The expected return includes the surprise portion of news announcements. e. Over time, the average unexpected return will be zero.
Over time, the average unexpected return will be zero.
Alice believes she can accurately forecast the future and makes business decisions based on this belief. Which characteristics does this belief represent? a. Overconfidence b. Overoptimism c. Affect heuristic d. Confirmation bias e. Representativeness heuristic
Overconfidence
Jeremy believes he excels at picking stock winners and thus trades frequently. Which characteristic does he most likely represent? a. Confirmation bias b. Frame dependence c. Overconfidence d. Representativeness heuristic e. Break-even effect
Overconfidence
Suzie owns five different bonds and twelve different stocks. Which one of the following terms most applies to her investments? a. Index b. Portfolio c. Collection d. Grouping e. Risk-free
Portfolio
Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which of the following? a. Portfolio return b. Portfolio weight c. Degree of risk d. Price-earnings ratio e. Index value
Portfolio weight
The last six times you purchased a stock you earned high returns within one year. Thus, you believe you will have the same result with your next stock purchase. This is an example of which one of the following? a. Recency bias b. Anchoring and adjustment c. Frame dependence d. Aversion to ambiguity e. Clustering illusion
Recency bias
Which term refers to the reliance on stereotypes or limited samples to form opinions about an entire class? a. Clustering illusion b. Law of small numbers c. Representativeness heuristic d. False consensus e. Recency bias
Representativeness heuristic
You have a tendency to take credit for the decisions you make that have good outcomes even when those outcomes are out of your control. On the other hand, you blame bad luck for your decisions that turn out badly. Which of these terms applies to you? a. Myopic loss aversion b. House money effect c. Money illusion d. Self-attribution bias e. Endowment effect
Self-attribution bias
Which one of the following is an investment risk that investors face in addition to firm-based risk and market-based risk? a. Management-related risk b. Inflation risk c. Supply chain risk d. Interest rate risk e. Sentiment-based risk
Sentiment-based risk
The present value of the interest tax shield is expressed as: a. TcD/Ra b. Vu + TcD c. TcDRa d. [EBIT(TcD)]/Ra e. TcD
TcD
The Daily News published an ad today wherein it announced its desire to purchase shares of a competing newspaper, the Oil Town Gossip. Which one of the following terms is best described by this announcement? a. Merger request b. Consolidation c. Tender offer d. Spinoff e. Divestiture
Tender offer
Which one of the following statements correctly applies to a legally defined merger? a. The acquiring firm retains its identity and absorbs only the assets of the acquired firm. b. The acquired firm is completely absorbed and ceases to exist as a separate legal entity. c. A new firm is created that includes all the assets and liabilities of the acquiring firm plus the assets only of the acquired firm. d. A new firm is created from the assets and liabilities of both the acquiring and acquired firms. e. A merger reclassifies the acquired firm into a new entity that becomes a subsidiary of the acquiring firm.
The acquired firm is completely absorbed and ceases to exist as a separate legal entity
Which one of the following does not represent a potential tax gain from an acquisition? a. The use of surplus funds b. The use of tax loss carryforwards c. The write-up of depreciable assets d. The use of unused debt capacity e. The increase in taxable income
The increase in taxable income
Which one of these statements is correct? a. Capital structure has no effect on shareholder value. b. The optimal capital structure occurs when the cost of equity is minimized. c. The optimal capital structure maximizes shareholder value. d. Shareholder value is maximized when WACC is also maximized. e. Unlevered firms have more value than levered firms when firms are profitable.
The optimal capital structure maximizes shareholder value
KN Markets has decided to acquire a controlling interest in BJ's by purchasing shares of BJ stock in the public markets. Which one of these statements correctly applies to this acquisition? a. This method of acquisition guarantees a quick and efficient merger. b. KN Markets is limited by law to obtaining a maximum of 49 percent of the shares prior to obtaining the approval of BJ management. c. The purchase of publicly traded shares may be more expensive than an outright merger. d. Once KN Markets obtains 80 percent of BJ's shares, the remaining BJ shareholders will be required to sell their shares to KN. e. KN Markets must obtain the approval of BJ's board of directors before purchasing shares.
The purchase of publicly traded shares may be more expensive than an outright merger
Which one of the following events would be included in the expected return of Sussex stock? a. The chief financial officer of Sussex unexpectedly resigned b. The labor union representing Sussex's employees unexpectedly called a strike c. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated d. The price of Sussex stock suddenly declined in value because researches accidentally discovered that one of the firm's products can be toxic to household pets e. The board of directors made an unprecedented decision to give sizeable bonuses to the firm's internal auditors for their efforts in uncovering wasteful spending
This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated
Which of the following statements related to unexpected returns is correct? a. all announcements by a firm affect that firm's unexpected returns b. Unexpected returns over time have a negative effect on the total return of a firm c. Unexpected returns are relatively predictable in the short-term d. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term e. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term
Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term
An automaker recently acquired a windshield manufacturer. Which type of an acquisition was this? a. Horizontal b. Longitudinal c. Conglomerate d. Vertical e. Indirect
Vertical
M&M Proposition II, without taxes, is the proposition that: a. the capital structure of a company has no effect on that company's value. b. the cost of equity depends on the return on debt, the debt-equity ratio, and the tax rate. c. a company's cost of equity is a linear function with a slope equal to (RA − RD). d. the cost of equity is equivalent to the required rate of return on assets. e. the size of the pie does not depend on how the pie is sliced.
a company's cost of equity is a linear function with a slope equal to (RA − RD)
The expected return on a tock computed using economic probabilities is: a. guaranteed to equal the actual average return on the stock for the next five years b. guaranteed to be the minimal rate of return on the stock over the next two years c. guaranteed to equal the actual return for the immediate twelve month period d. a mathematical expectation based on a weighted average and not an actual anticipated outcome e. the actual return you should anticipate as long as the economic forecast remains constant
a mathematical expectation based on a weighted average and not an actual anticipated outcome
Assume the shareholders of a target firm benefit from being acquired in a stock transaction. Given this, these shareholders are most apt to realize the largest benefit if the: a. acquiring firm has the better management team and replaces the target firm's managers. b. management of the target firm is more efficient than the management of the acquiring firm which replaces them. c. management of both the acquiring firm and the target firm are as equivalent as possible. d. current management team of the target firm is kept in place even though the managers of the acquiring firm are more suited to manage the target firm's situation. e. new management team is technologically knowledgeable but yet ineffective.
acquiring firm has the better management team and replaces the target firm's managers
In a merger the: a. legal status of both the acquiring firm and the target firm is terminated. b. acquiring firm retains its pre-merger legal status. c. acquiring firm acquires the assets, but not the liabilities, of the target firm. d. shareholders of the target firm have little, if any, say as to whether or not the merger occurs. e. target firm continues to exist but will be a wholly owned subsidiary of the acquiring firm.
acquiring firm retains its pre-merger legal status
Bill feels that he possesses a good dose of "street smarts." Thus, he makes his business decisions based on how a project feels to him rather than taking the time to financially analyze a project. This type of behavior is referred to as: a. overconfidence. b. endowment effect. c. money illusion. d. affect heuristic. e. sentiment-based risk.
affect heuristic
When evaluating an acquisition you should: a. concentrate on book values and ignore market values. b. focus on the total cash flows of the merged firm but ignore incremental cash flows. c. apply the rate of return that is relevant to the incremental cash flows. d. ignore any one-time acquisition fees or transaction costs. e. ignore any potential changes in management.
apply the rate of return that is relevant to the incremental cash flows
In a tax-free acquisition, the shareholders of the target firm: a. receive income that is considered to be tax-exempt. b. gift their shares to a tax-exempt organization and therefore have no taxable gain. c. are viewed as having exchanged shares on a dollar-for-dollar basis. d. sell their shares to a qualifying entity thereby avoiding both income and capital gains taxes. e. sell their shares at cost thereby avoiding the capital gains tax.
are viewed as having exchanged shares on a dollar-for-dollar basis
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 costs of all future funding sources. d. both the returns currently required by its debtholders and stockholders. e. the company's original debt-equity ratio
both the returns currently required by its debtholders and stockholders
Unsystematic risk: a. can be effectively eliminated by portfolio diversification. b. is compensated for by the risk premium. c. is measured by beta. d. is measured by standard deviation. e. is related to the overall economy.
can be effectively eliminated by portfolio diversification.
The standard deviation of a portfolio: a. is a 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 compromise 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.
The standard deviation of a portfolio: a. is a measure of that portfolio's systematic risk. b. is a weighted average of the standard deviations of the individual securities held in that portfolio. c. measures the amount of diversifiable risk inherent in the portfolio. d. serves as the basis for computing the appropriate risk premium for that portfolio. e. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.
can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.
Based on M&M Proposition I with taxes, the weighted average cost of capital: a. is equal to the aftertax cost of debt. b. has a linear relationship with the cost of equity capital. c. is unaffected by the tax rate. d. decreases as the debt-equity ratio increases. e. is equal to RU(1 − TC).
decreases as the debt-equity ratio increases
Financial risk is: a. the risk inherent in a company's operations. b. a type of unsystematic risk. c. inversely related to the cost of equity. d. dependent upon a company's capital structure. e. irrelevant to the value of a company
dependent upon a company's capital structure
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 firm's overall capital structure. d. should be applied as the discount rate for all other projects considered by the firm. e. depends upon how the funds raised for that project are going to be spent.
depends upon how the funds raised for that project are going to be spent
The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs. a. flotation b. issue c. direct bankruptcy d. indirect bankruptcy e. unlevered
direct bankruptcy
A company's overall cost of equity is: a. generally less than its WACC given a debt-equity ratio of .5. b. unaffected by changes in the market risk premium. c. directly related to the risk level of the firm. d. generally less than the firm's aftertax cost of debt. e. inversely related to changes in the level of inflation
directly related to the risk level of the firm
The tendency to sell winners and hold losers is known as the: a. representativeness heuristic. b. disposition effect. c. house money effect. d. self-attribution bias. e. affect heuristic.
disposition effect
The static theory of capital structure advocates that the optimal capital structure for a company: a. is highly dependent upon a constant debt-equity ratio over time. b. remains fixed over time. c. is independent of the company's tax rate. d. is independent of the company's debt-equity ratio. e. equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt.
equates marginal tax savings from additional debt to the marginal increased bankruptcy costs of that debt
Assume you are reviewing a graph that plots earnings per share (EPS) against earnings before interest and taxes (EBIT). The steeper the slope of the plotted line the: a. lower the impact of financial leverage. b. lower the debt-equity ratio. c. higher the tax rate. d. greater the sensitivity of EPS to changes in EBIT. e. lower the probability of a negative EPS.
greater the sensitivity of EPS to changes in EBIT
If a company uses its WACC as the discount rate for all of the projects it undertakes then the company will tend to: Select one: a. accept all positive net present value projects. b. increase the average risk level of the company over time. c. reject all high-risk projects. d. reject all negative net present value projects. e. favor low-risk projects over high-risk projects.
increase the average risk level of the company over time
Incorporating flotation costs into the analysis of a project will: a. cause the project to be improperly evaluated. b. increase the net present value of the project. c. increase the project's rate of return. d. increase the initial cash outflow of the project. e. have no effect on the present value of the project.
increase the initial cash outflow of the project
When a firm has flotation costs equal to 8.3 percent of the funding need, project analysts should: a. increase the project's discount rate to offset these expenses by multiplying the company's WACC by 1.083. b. increase the project's discount rate to offset these expenses by dividing the company's WACC by (1 − .083). c. add 8.3 percent to the company's firm's WACC to determine the discount rate for the project. d. increase the initial project cost by multiplying that cost by 1.083. e. increase the initial project cost by dividing that cost by (1 − .083).
increase the initial project cost by dividing that cost by (1 − .083)
All of the following are examples of cost reductions that can result from an acquisition except: a. reducing the number of management personnel required. b. lowering office costs by combining job functions. c. allocating fixed overhead across a wider range of products. d. benefiting from economies of scale when purchasing raw materials. e. increasing the firm's market share.
increasing the firm's market share
A proposed acquisition is most apt to create synergy by: a. decreasing the market power of the combined firm. b. disbanding the distribution network of the combined firm. c. eliminating any strategic advantages of the target firm. d. increasing the utilization of the acquiring firm's assets. e. increasing the overhead costs.
increasing the utilization of the acquiring firm's assets
The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs. a. flotation b. direct bankruptcy c. indirect bankruptcy d. financial solvency e. capital structure
indirect bankruptcy
A company's pretax cost of debt: a. is based on the current yield to maturity of the company's outstanding bonds. b. is equal to the coupon rate on the latest bonds issued by the company. c. is equivalent to the average current yield on all of a company's outstanding bonds. d. is based on the original yield to maturity on the latest bonds issued by a company. e. has to be estimated as it cannot be directly observed in the market.
is based on the current yield to maturity of the company's outstanding bonds
Assume Russo's has a debt-equity ratio of .4 and uses the capital asset pricing model to determine its cost of equity. As a result, the company's cost of equity: a. is affected by the firm's rate of growth projections. b. implies that the firm pays out all of its earnings to its shareholders. c. is dependent upon a reliable estimate of the market risk premium. d. would be unaffected if the dividend discount model were applied instead. e. will be unaffected by changes in overall market risks.
is dependent upon a reliable estimate of the market risk premium
The aftertax cost of debt: a. varies inversely to changes in market interest rates. b. will generally exceed the cost of equity if the relevant tax rate is zero. c. will generally equal the cost of preferred if the tax rate is zero. d. is unaffected by changes in the market rate of interest. e. is highly dependent upon a company's tax rate.
is highly dependent upon a company's tax rate
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
The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: a. number of shares owned of each stock b. market price per share of each stock c. market value of the investment in each stock d. original amount invested in each stock e. cost per share of each stock held
market value of the investment in each stock
If a stock portfolio is well diversified, then the portfolio variance: a. will equal the variance of the most volatile stock in the portfolio 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's overall cost of capital from changing over time. c. will cause the company's overall cost of capital to decrease over time. d. decreases the value of the company over time. e. negates the company's 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
Last month, Keyser Design acquired all of the assets and liabilities of Tenor Machine Works. The combined firm is known as Keyser Design. Tenor Machine Works no longer exists as a separate entity. This acquisition is best described as a: a. merger. b. consolidation. c. tender offer. d. spinoff. e. divestiture.
merger
The capital structure that maximizes the value of a company also: Select one: a. minimizes financial distress costs. b. minimizes the cost of capital. c. maximizes the present value of the tax shield on debt. d. maximizes the value of the debt. e. maximizes the present value of the bankruptcy costs.
minimizes the cost of capital
For financial statement purposes, goodwill created by an acquisition: a. must be amortized on a straight-line basis over 10 years. b. must be reviewed each year and amortized to the extent that it has lost value. c. is expensed evenly over a 20-year period. d. never affects the profits of the acquiring firm. e. is recorded in an amount equal to the fair market value of the assets of the target firm.
must be reviewed each year and amortized to the extent that it has lost value
Jenner's is a multi-division firm that uses its overall WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to: a. receive less project funding if its line of business is riskier than that of the other divisions. b. avoid risky projects so it can receive more project funding. c. become less risky over time based on the projects that are accepted. d. have an equal probability with all the other divisions of receiving funding. e. prefer higher risk projects over lower risk projects.
prefer higher risk projects over lower risk projects
The Road Stop is a national hotel chain with a cost of capital of 12.4 percent. This chain is considering opening a high-end resort that is expected to have a cost of capital that is at least 13 percent. The estimated net present value of the resort project is $500 when discounted at 12.4 percent. The best representation of this situation is that the resort project should: a. be accepted immediately. b. be financed solely with debt in order for the project to have a positive NPV. c. probably be put on hold until its cost of capital can be lowered. d. be permanently rejected. e. probably be expanded.
probably be put on hold until its cost of capital can be lowered
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm that has a similar line of business as the project, the manager is utilizing the _____ approach. a. subjective risk b. pure play c. divisional cost of capital d. capital adjustment e. security market line
pure play
The weighted average cost of capital for a firm with debt is the: a. discount rate that the firm should apply to all of the projects it undertakes. b. rate of return a company must earn on its existing assets to maintain the current value of its stock. c. coupon rate the firm should expect to pay on its next bond issue. d. minimum discount rate the firm should require on any new project. e. rate of return debtholders should expect to earn on their investment in this firm.
rate of return a company must earn on its existing assets to maintain the current value of its stock
The cost of preferred stock is computed the same as the: a. pretax cost of debt. b. rate of return on an annuity. c. aftertax cost of debt. d. rate of return on a perpetuity. e. cost of an irregular growth common stock.
rate of return on a perpetuity
All of the following create limits to arbitrage except: a. firm-specific risk. b. noise traders. c. thinly traded securities. d. rational traders. e. implementation costs.
rational traders
The expected risk premium on a stock is equal to the expected return on the stock minus the: a. expected market rate of return b. risk-free rate c. inflation rate d. standard deviation e. variance
risk-free rate
Johnson Co. and Peabody Enterprises are both manufacturers of plastic products. These two firms have decided to work together to find a more efficient way to recycle rejected products. Thus, the two companies are each going to assign two engineers to this project and have agreed to share any and all costs. This project is an example of a: a. consolidation. b. merged alliance. c. joint venture. d. takeover project. e. strategic alliance.
strategic alliance
Which of the following is a risk that applies to most securities? a. Unsystematic b. Diversifiable c. Systematic d. Asset-specific e. Industry
systematic
Up until three years ago, A.C. Dime opened an average of ten new retail stores a year. One of every ten new stores had to be closed within two years due to poor sales. This 90 percent success ratio was fairly steady for over 30 years. Starting three years ago, the firm has opened 40 new stores and every one had significant profits within six months. Management believes their recent success is not just a random event and that all future stores will be profitable. Thus, the managers have decided to open a minimum of 15 new stores each year. The managers are suffering from: a. arbitrage limitations. b. anchoring and adjustment. c. aversion to ambiguity. d. the clustering illusion. e. myopic aversion.
the clustering illusion
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 tax rates. b. the model's applicability to all corporations. c. is the model's consideration of risk. d. the stability of the computed cost of equity over time. e. the simplicity of the model.
the simplicity of the model
M&M Proposition I with taxes is based on the concept that: a. the optimal capital structure is the one that is totally financed with equity. b. capital structure is irrelevant because investors and companies have differing tax rates. c. WACC is unaffected by a change in the company's capital structure. d. the value of a taxable company increases as the level of debt increases. e. the cost of equity increases as the debt-equity ratio increases
the value of a taxable company increases as the level of debt increases
If a company has the optimal amount of debt, then the: a. direct financial distress costs must equal the present value of the interest tax shield. b. value of the levered company will exceed the value of the unlevered company. c. company has no financial distress costs. d. Value of the firm is equal to VL + TCD. e. debt-equity ratio is equal to 1.
value of the levered company will exceed the value of the unlevered company
The value of a target firm to the acquiring firm is equal to the: a. value of the target firm as a separate entity plus the incremental value derived from the acquisition. b. purchase cost of the target firm. c. value of the merged firm minus the value of the target firm as a separate entity. d. purchase cost plus the incremental value derived from the acquisition. e. incremental value derived from the acquisition.
value of the target firm as a separate entity plus the incremental value derived from the acquisition
If Food Markets were to acquire Meat Processors, the acquisition would be classified as a _____ acquisition. a. vertical b. longitudinal c. conglomerate d. horizontal e. integrated
vertical
The average of a company's cost of equity, cost of preferred, and aftertax cost of debt that is weighted based on the company's capital structure is called the: Select one: a. reward-to-risk ratio. b. weighted capital gains rate. c. structured cost of capital. d. subjective cost of capital. e. weighted average cost of capital.
weighted average cost of capital
The value of a firm is maximized when the: a. cost of equity is maximized. b. tax rate equals the cost of capital. c. levered cost of capital is maximized. d. weighted average cost of capital is minimized. e. debt-equity ratio is minimized
weighted average cost of capital is minimized
The expected return on a stock given various states of the economy is equal to the: a. highest expected return given any economic state b. arithmetic average of the returns for each economic state c. summation of the individual expected rates of return d. weighted average of the returns for each economic state e. return for the economic state with the highest probability of occurrence.
weighted average of the returns for each economic state