Finc exam 3
If a person finds a buyer for the 100 shares of a company he owns, this is:
55a direct search market transaction.
Which of the following is a characteristic of common stock?
Limited liability for owners
Which of the following methods is typically used to estimate a firm's cost of equity?
The CAPM
When the discount rate estimated is too low, firms run the risk of accepting a negative NPV project.
True
According to the independent broker/dealer, stock represents
a tiny portion of ownership in the corporation.
What financial instruments comprise a firm's capital structure?
a. Common stock b. Preferred stock c. Bonds
Which of the following is true of capital budgeting decisions
a. They define a firm's lines of business and its inherent business risk. b. They create value for a firm when the value of the selected productive assets is worth more than their cost. d. They can involve substantial cash outlays, which once made are not easily reversed.
Although the CAPM is theoretically the correct model to use when estimating the expected rate of return on an investment, it is difficult to apply in practice because
a. firms do not issue publicly traded shares for each individual project. b. individual project betas are almost impossible to be determined. c. analysts do not have a way to directly estimate the returns related to each individual project.
The cost of capital is:
a. the required rate of return for new projects that have risk that is similar to that of the overall firm. b. the rate of return a firm earns on its investments to satisfy the required rate of return for the firm's investors. c. the opportunity cost of using funds on projects.
Of the four capital budgeting techniques, the one that managers use the least is:
accounting rate of return.
If a firm can undertake only some of the value-adding projects available to it because of limited funds, the firm must engage in:
capital rationing.
If a project's IRR exceeds its _____, the project should be _____.
cost of capital; accepted
Depreciation expense _____.
decreases taxable income and decreases taxes
Capital budgeting is the process of:
determining which capital investments a firm should make
A weakness of the accounting rate of return technique is, it:
does not distinguish between revenue and cash flows.
Growth stocks are typically defined as the stocks of companies whose
earnings are growing at above-average rates.
Bond contracts include specific terms, including all of the following EXCEPT
the price at which the bond will be sold in the bond market.
The market value of a firm's assets must equal
the value of the cash flows the assets are expected to generate.
For firms that issue several types of debt, the correct cost to use when estimating its WACC is _____
the weighted average after-tax cost of all the debt types
The owners of Finagle a Bagel are more comfortable with debt than using funds provided with venture capital because
they left the corporate world to work for themselves and using venture capital would result in their working for the venture capital providers.
The best method to use when estimating a firm's discount rate is the _____.
weighted average cost of capital approach
The current cost of debt to use when estimating a firm's WACC is the _____.
yield to maturity on its outstanding bonds
Trade credit is
the amount of time vendors give customers to pay for their products.
Working capital management in wholesale is different from retail because
the cash is received quickly and available to pay bills in retail operations, while in wholesale operations, the cash is not paid right away but the bills must still be paid.
A situation where a firm would not want to use its own WACC to evaluate a risky project would be when:
the cost of capital of a pure-play comparable that is similar to the project can be found.
According to the finance balance sheet equation:
the market value of a firm's assets must equal the market value of its liabilities and the market value of its equity.
The value of a firm's equity is calculated as the sum of the present value of all expected future cash flows.
True
Which of the following is one of the steps necessary for conducting a capital budgeting analysis of a project
Estimating the project's future cash flows
Which one of the following is an advantage of the NPV method of analyzing capital projects?
It uses a discounted cash flow technique to adjust for the time value of money.
Which of the following is true of the cost of debt?
A firm's interest payments are tax-deductible
Which of the following is a weakness of the payback period?
Cash flows are not discounted.
Which of the following has a right to vote in the election of the board of directors of a company?
Common stockholders
Which of the following rates should be used to calculate a project's net present value
Cost of capital
Which of the following capital component costs must be adjusted for taxes?
Cost of debt
Which one of the following markets is a type of secondary market for securities in the US?
Dealer
Which of the following steps is necessary when computing the value of a common stock?
Determining the required rate of return based on the riskiness of the cash flows
In which of the following types of security markets do sellers often rely primarily on word-of-mouth communication to find interested buyers?
Direct search
Which of the following is a simplifying assumption that is made when applying the dividend discount model to common stock valuation?
Dividend growth rate is not equal to the required rate of return.
Which of the following projects would typically have the lowest cost of capital?
Efficiency projects
Financial analysts use book values of each capital component when estimating their weights for use in the WACC calculation.
False
If a corporation does not declare and pay preferred dividends as scheduled, it is technically in default and can be forced into bankruptcy by preferred stockholders.
False
Other things held constant, the use of accelerated depreciation rates would make the NPV of a project smaller.
False
Preferred stock is legally a form of debt of a corporation.
False
The IRR and NPV methods always rank projects in the same order.
False
The IRR is the discount rate that makes the NPV positive
False
The MIRR is the interest rate that equates the present value of the project's cash outflows to the present value of its cash inflows
False
The accounting rate of return is better than the payback period since it does not ignore the time value of money.
False
The cost arising from using a building that could have been leased out is an example of a sunk cost.
False
The cost of capital for a project is its return on equity.
False
The cost of debt for a firm is the same as its dividend payments for any period.
False
The market value of a firm's assets must always equal the market value of the firm's shareholders' equity.
False
The net present value of a project equals the value of the assets used in the project.
False
When calculating the WACC, book values of debt, preferred stock, and common stock are appropriate for determining the weights associated with these costs of capital.
False
When estimating the cost of debt, one should average the costs of short-term and long-term debt issues of a corporation.
False
When faced with mandatory contingent projects, it is best to evaluate each project independently on its own merits.
False
Which of the following is an example of an OTC market?
NASDAQ
Which of the following capital budgeting techniques, is the most appropriate one for evaluating projects?
Net present value
Which of the following capital budgeting technique ignores the time value of money?
Payback period
When estimating the cost of debt to use in the WACC, which of the following types of debt should be included?
Publicly traded bonds
Which one of the following is an example of an incremental capital expenditure?
Purchase of additional machinery
Which of the following represents an example of key reasons for making capital expenditures?
Replacing production equipment
The constant growth dividend model cannot be applied to value the stock of a company whose dividends are declining at a constant rate.
The growth rate must be less than the required rate of return.
The value of a stock that experiences supernormal growth can be calculated as the present value of all dividends during the period of supernormal growth plus the present value of a constantly growing dividend.
True
Cash flows used for analyzing capital budgeting proposals differ from those included in the accounting statement of cash flows in which of the following ways?
They are forward looking, while accounting cash flows are historical.
Which of the following is a major role of secondary markets?
To provide good marketability for securities
A financial analyst should consider the impact on a chain's existing restaurants when the company is evaluating the feasibility of opening another restaurant.
True
Capital budgeting decisions are the most important ones managers make because they help to select investments in long-term assets that increase the value of a firm.
True
Common stockholders are owners of a corporation.
True
Growth stocks typically pay little or no dividends.
True
Profitability index (PI) is a measure of the value a project generates for each dollar invested in that project.
True
The Capital Asset Pricing Model is an appropriate method of calculating a firm's cost of equity when no dividends are being paid.
True
The NYSE and NASDAQ are two of the three largest exchanges in the world based on the value of shares traded.
True
The bid price is the price that a dealer pays for a security.
True
The cost of equity for a firm is a weighted average of the costs of the different types of stock that the firm has outstanding at a particular point in time.
True
The cost of preferred stock is the same as its dividend yield.
True
The dealer's selling price of a given stock is also known as the ask price.
True
The equity market risk premium is typically estimated as the difference between the average return on the U.S. stock market and that on long-term U.S. government bonds.
True
The valuation of real assets is less straightforward than the valuation of financial assets
True
Which of the following is a key disadvantage of the IRR method?
With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.
A firm's cost of capital is a weighted average of all its _____.
financing costs
The value of a share of stock depends on
how often it will pay a dividend.
When estimating the free cash flows for a project we must account for _____
incremental cash flows from capital expenditures.
When we calculate the free cash flows for a project, we first compute the:
incremental cash flows from operations.
The NPV and IRR methods will always agree when you are evaluating _____ projects and the project's cash flows are _____.
independent; conventional
One of the main reasons why the discounted payback period is not widely used by managers is that:
it ignores all cash flows that occur after the arbitrary cutoff period.
Bonds have _________________________ than stock.
less risk and less upside potential for return
When estimating the risk-free rate to use in the CAPM for determining the firm's cost of equity it is best to use the _____
long-term Treasury bond yield.
From the customer's perspective, _______ trade credit terms are better because _________.
longer; the customer has more time to sell its products to get cash to pay the vendors.
Managers should make fairly accurate estimates of their cost of capital so as to_____.
make correct investment decisions.
The reason we cannot apply the constant growth dividend model in the case where the growth rate, g, is greater than or equal to the required rate, R, is because it would result in the value of the stock becoming:
negative
A project's salvage value is likely to be ignored in the _____.
payback period technique
Preferred stock resembles a bond because
preferred stock pays fixed dividends which is similar to the interest paid on bonds.
Preferred stock is considered to be a special type of debt rather than equity because
preferred stockholders receive a fixed dividend.
False
reinvests earnings to provide dividends in the future.
The owners of Finagle a Bagel were able to get cash during the recession by
selling real estate to banks.
Over the life of a project, a firm using the MACRS method rather than the straight-line method will have _____.
stable total taxes
All of the following statements about stock indexes are true EXCEPT
stock indexes are unbiased and perfect indicators of market activity.
The capital budgeting process starts with a firm's
strategic plan
Cash flows over a project's life should include _____.
sunk costs
According to the independent broker/dealer, individual investors must never lose sight of the fundamental nature of the stock market, which means
that the stock market is a market—it is the pairing of the seller and the buyer of the stock.
