Module # 3
what will your capital gain be if you hold 40 shares of stock and the stock price rises from $27 to $40
$520
IF your total dollar return was $7 and your dividend was $2, then the price change on your stock must've been
+5$
types of systematic risk
- future rates of inflation - regulatory changes in tax rates
what are the two main benefits of performing sensitivity analysis?
- it identifies the variable that has the most effect on NPV - it reduces a false sense of security by giving a range of values for NPV instead of a single value
what are reasons why NPV is considered a superior capital budgeting technique?
- npv considers all the cash flows - npv considers time value of money
when using ______ all the variable except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable
- sensitivity analysis
what does variance measure
- the dispersion of the sample returns -riskiness of a securities' returns
what is needed to describe the distribution of stock returns?
- the standard deviation of returns - the mean return
when evaluating cost cutting proposals how are OCF affected?
- there is an additional depreciation deduction - the decrease in costs increases operating income
____ risk is reduced as more securities are added to the portfolio
- unique -unsystematic - idiosyncratic
investment in networking capital arises when
-credit sales are made -inventory is purchased -cash is kept for unexpected expenditures
the risk free asset has a beta of
0.00
you buy a share of stock for $100. At the end of one year the stock price is $114 and $1 dividend is paid out. If you do not sell the stock, your total annual return is
15%
the marketing department has projected that the firm's market share will be 15% of industry sales. Industry sales should total 30,000 units. if the price per unit is $150, the firm's expected sales revenue will be
675,000 .15 x 30,000 x 150
the calculation of a portfolio beta is similar to the calculation of
a portfolio's expected return
cash flows should be considered on an _____ basis
after tax
a capital gain on a stock results from
an increase in stock price
the systematic risk principle argues that the market does not reward risks that
are borne unnecessarily
from a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage
as low as possible
the dividend yield for a one-year period is equal to the annual dividend amount divided by the
beginning stock price
incremental cash flows come about as a ____ consequence of taking a project under consideration
direct
the total dollar return on a stock is the sum of
dividends and capital gains
it is _____ to increase operating leverage than to decrease it
easier
when developing cash flows for capital budgeting it is ____ to overlook important items
easy
If kellogg's introduces a new brand of cereal, it will most likely lead to ___ in its sales of existing cereals
erosion, i.e. a decrease
interest expenses incurred on debt financing are _____ when computing cash flows form a project
ignored
dividends are the ____ component of the total return from investing in a stock
income
an increase in depreciation expense will ____ cash flow operations
increase
as deprecation expenses _____ net income and taxes will decrease while cash flows will increase
increase
if the tax rate increases, the value of the depreciation tax shield will _____
increase
an investment will have a negative NPV when its expected return is ____ _____ what the financial markets offer for the same risk
less than
account receivable and accounts payable are not an issue with project cash flow estimation unless changes in ___ are overlooked
net working capital
the difference between a firm's current assets and its current liabilities is known as the
net working capital
benefits lost due to taking on a particular project
opportunity costs
if investors are risk adverse, it is reasonable to assume that the risk premium for the stock market will be
positive
there is generally a ____ relationship between beta and the expected return on a security
positive
the first step in estimating cash flows is to determine the ____ cash flows
relevant
in a simulation, the average NPV and the spread of NPV around the average are determined by
repeated random drawings
have already occurred and are not affected by accepting or rejecting a project
sunk costs
when an investor is diversified only ____ risk matter
systematic
which type or risk does not change as we add more securities to a portfolio?
systematic, or market risk
what is the slope of the security market line (SML)?
the market risk premium
In a competitive market, positive NPV projects are
uncommon
the basic approach to evaluating cash flow and NPV estimates involves asking
what-if questions
when a company declares a dividend, shareholders generally receive
cash
the minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the
cost of capital
the ____ rate of return is the difference between risky returns and risk-free returns
excess
you bought one share of stock for $100 and received a $2 dividend. if the price of the stock rose to $103, then your total dollar return would be
$5 103-100 +2 = $5
once cash flows have been estimated, which of the following investment criteria can be applied to them?
- payback period - irr - npv
Which statements regarding the relationship between book value, sales price, and taxes are true when a firm sells a fixed asset?
- there will be a tax savings if the book value exceeds the sales price - taxes are based on the difference between book value and the sales price - book value represents the purchase price minus he accumulated depreciation
the possibility that errors in projected cash flows will lead to incorrect decisions known as
-estimation risk or - forecasting risk
what is the expected return of a portfolio consisting of stocks A and B if the expected return is 10% for A and 15% for B?
.5 x 10% + .5 x 15% = 12.5%
if security ABC has a beta of 1.5 and security has EXY has a beta of 1, what is the beta portfolio that is equally invested in both securities?
.5 x1.5 + .5x1 =1.25
what is the return on a portfolio that consists of $50,000, $30,000 and $20,000. The expected returns are 7%, -3%, and 18%
.5x7% + .3X-3% + .2x 18% = 6.2%
the annual stock market return for berry company were 19%, 13% and -8% what was the arrhythmic mean for those 3 years?
8%
what is the OCF is sales are 200,000 total cash costs are 190,636 and tax bill is 1144
8220
what is a scenario analysis
it determines the impact on npv of a set of events relating to a specific scenario
in the context of capital budgeting, what does sensitivity analysis do?
it examines how sensitive a particular NPV calcuation is to changes in underlying assumptions
what is a risk premium?
it is additional compensation for taking risk, over and above the risk free rate
what are the two main drawbacks of sensitivity analysis?
it may increase the false sense of security among managers if all pessimistic estimates of NPV are positive it does not consider interaction among variables
you can't expect cash flow estimate to be ____ every time
exactly right
the computation of equivalent annual costs is useful when comparing projects with unequal
lives
what is systematic risk?
risk that pertains to a large number of assets
it would be useful to understand the ____ of the risk premium on a risky asset is determined
size
