Finance FINAL

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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. Sunk
D. Erosion
E. Incremental

Sunk Cost

Samuelson Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule?

A. Project A only
B. Neither A nor B
C. Both A and B
D. Answer cannot be determined based on the information given.
E. Project B only

Project A only

What has serious problems and should not be used?
A. Internal rate of return
B. Discounted payback
C. Average accounting rate of return
D. Payback
E. Net present value

Average accounting rate of return

The discount rate that makes the net present value of an investment exactly equal to zero is called the:
A. average accounting return
B. profitability index
C. external rate of return
D. equalizer
E. internal rate of return

Internal rate of return

Project cash flows should:
A. Be pre-tax
B. Include all sunk costs
C. Include all incremental costs
D. Include all financing costs
E. Include all of the above

Include all incremental costs

Bell Weather Goods has several proposed independent projects that have positive NPVs. However, the firm cannot initiate any of the projects due to a lack of financing. This situation is referred to as:
A. financial rejection.
B. project rejection.
C. soft rationing.
D. capital rationing.
E. marginal rationing.

Capital rationing

Steve is fairly cautious when analyzing a new project and thus he projects the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Which type of analysis is Steve using?
A. simulation testing
B. sensitivity analysis
C. rationing analysis
D. scenario analysis
E. break-even analysis

Scenario Analysis

Which of the following variables will be at their highest expected level under a worst case scenario?
I. fixed cost
II. sales price
III. variable cost
IV. sales quantity

I and III

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?
A. expected risk formula
B. time value of money equation
C. capital asset pricing model
D. unsystematic risk equation
E. market performance equation

Capital asset pricing model

Which one of the following risks is irrelevant to a well-diversified investor?
A. systematic portion of a surprise
B. market risk
C. systematic risk
D. nondiversifiable risk
E. unsystematic risk

unsystematic risk

Which of the following are examples of diversifiable risk?
I. earthquake damages an entire town
II. federal government imposes a $100 fee on all business entities
III. employment taxes increase nationally
IV. toymakers are required to improve their safety standards
A. I and IV only
B. II and III only
C. I, III, and IV only
D. I and III only
E. II and IV only

I and IV

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. valuation period.
C. profitability period.
D. discounted cash period.
E. payback period

payback period

The length of time a firm must wait to recoup, in present value terms, the money it has in invested in a project is referred to as the:
A. net present value period.
B. discounted payback period.
C. internal return period.
D. payback period.
E. discounted profitability period.

Discounted payback period

Which of the following are advantages of the payback method of project analysis?
I. works well for research and development projects
II. liquidity bias
III. ease of use
IV. arbitrary cutoff point

A. II and III only
B. I and III only
C. II, III, and IV only
D. II and IV only
E. I and II only

II and III

The IRR for the following set of cash flows is what percent?

0 −$9,868
1 3,400
2 5,300
3 6,900

23.64%

A project's average net income divided by its average book value is referred to as the project's average:
A. accounting return.
B. internal rate of return.
C. net present value.
D. profitability index.
E. payback period.

Accounting return

The internal rate of return is defined as the:

A. maximum rate of return a firm expects to earn on a project.
B. discount rate that equates the net cash inflows of a project to zero.
C. rate of return a project will generate if the project in financed solely with internal funds.
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

Which of the following are considered weaknesses in the average accounting return method of project analysis?
I. exclusion of time value of money considerations
II. need of a cutoff rate
III. easily obtainable information for computation
IV. based on accounting values

A. II and III only
B. I only
C. I and IV only
D. I, II, and IV only
E. I, II, III, and IV

I, II, and IV

Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods?
A. accounting rate of return
B. net present value
C. profitability index
D. payback
E. internal rate of return

Net present value

Which two methods of project analysis are the most biased towards short-term projects?

A. discounted payback and profitability index
B. payback and discounted payback
C. net present value and internal rate of return
D. net present value and discounted payback
E. internal rate of return and profitability index

Payback and discounted payback

An analysis of the change in a project's NPV when a single variable is changed is called _____ analysis.

A. sensitivity
B. break-even
C. simulation
D. scenario
E. forecasting

Sensitivity

Which one of the following is a risk that applies to most securities?

A. unsystematic
B. asset-specific
C. diversifiable
D. total
E. systematic

Systematic

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?
A. market
B. nondiversifiable
C. total
D. portfolio
E. unsystematic

Unsystematic

The principle of diversification tells us that:

A. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk.
B. spreading an investment across many diverse assets will eliminate all of the systematic risk.
C. spreading an investment across many diverse assets will eliminate some of the total risk.
D. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk.
E. spreading an investment across five diverse companies will not lower the total risk

Spreading an investment across many diverse sets will eliminate some of the total risk

Unsystematic risk:
A. is compensated for by the risk premium.
B. is related to the overall economy.
C. can be effectively eliminated by portfolio diversification.
D. is measured by beta.
E. is measured by standard deviation.

Can be effectively eliminated by portfolio diversification

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?
A. standard deviation
B. reward-to-risk ratio
C. beta
D. price-earnings ratio
E. risk ratio

Beta

Which one of the following is an example of systematic risk?

A. corn prices increase due to increased demand for alternative fuels
B. a city imposes an additional one percent sales tax on all products
C. a flood washes away a firm's warehouse
D. investors panic causing security prices around the globe to fall precipitously
E. a toymaker has to recall its top-selling toy

Investors panic causing security prices around the globe to fall precipitously

The primary goal of financial management?

A. Avoid financial distress
B. Maximize dividends per share
C. Maximize the current value per share of the existing stock
D.Maximize firm efficiency

Maximize the current value per share of the existing stock

As the Yield to maturity increases the:

A. Value of the bond decreases
B. Longer the time to Maturity
C. Lower the Desired coupon
D. Value of the bond increases

Value of the bond decreases

The financial statement summarizing a firm's performance over a period of time

A. Income statement
B. statement of cash flows
C. Balance sheet
D. Shareholders' Equity sheet

Income statement

An analysis of what happened to NPV when you change only one variable is?
A. Break-even
B. Simulation
C. Scenario
D. Sensitivity

Sensitivity

Do NPV and IRR always lead to the same decision?

A. yes
B. No

no

What are the three financial management decisions?

Capital budgeting, capital structure and working capital

What is the agency problem?

Conflicts between management and stockholders

Financial planning model ingredients

1)Sales forecast
2)Asset requirements
3)Financial requirements
4)Economic assumptions

The cash flows of a new project that come at the expense of a firm's existing projects are:
A. Salvage value expenses.
B. Net working capital expenses.
C. Sunk costs.
D. Opportunity costs.
E. Erosion costs.

Erosion costs

A firm is considering a project which would increase accounts receivable by $10,000, accounts payable by $35,000, and inventory by $30,000. Which of the following is true?

A. Net working capital has increased.
B. Sales will increase.
C. Payments to creditors will slow.
D. Net working capital has decreased.
E. This is a net source of cash.

Net working capital had increased

Which of the following would be considered a use of funds?
I. An increase in receivables
II. An increase in payables
III. An increase in inventory
IV. An increase in sales
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) I, III, and IV only

I and III only

The tax rate applicable to the next dollar of taxable income is called the _____ tax rate.

a. next
b. absolute
c. total
D. marginal
e. average

Marginal

16. Which of the following correctly describe a dealer market?

I. Dealers match buyers with sellers.
II. Dealers buy and sell for themselves at their own risk.
III. Dealer trading occurs over-the-counter.
IV. Dealer transactions occur on a trading floor.

a. I and IV only
b. I and III only
c. II and IV only
d. I, II, and III only
E. II and III only

II and III only

A series of equal cash flows that occur at the beginning of each time period for a limited number of time periods is called a(n):

a. perpetuity due.
b. perpetuity.
c. beginning annuity.
D. annuity due.
e. ordinary annuity.

Annuity due

Which one of the following is a breakdown of the ROE into its three component parts?

a. equity analysis
b. sustainable growth
C. Du Pont identity
d. profitability ratios
e. efficiency breakout

Du Pont Identity

A real rate of return has been adjusted for:

A. default risk.
B. market risk.
C. interest rate risk.
D. taxes.
E. inflation.

Inflation

An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.
a. forecasting
b. scenario
c. sensitivity
d. simulation
e. break-even

Simulation

7. What is the yield-to-maturity of a bond?

A bondholder's required rate of return for holding a bond

18. What kind of issues do I get to vote on as a common shareholder

Directors, mergers, auditors

Which of the following questions are appropriate to address during the financial planning process?

I. Should the firm merge with a competitor?
II. Should additional shares of stock be sold?
III. Should a particular division be sold?
IV. Should a new product be introduced?

II, III, and IV only

The cash flow of a firm which is available for distribution to the firm's creditors and stockholders is called the
A. net working capital.
B. operating cash flow.
C. cash flow to stockholders.
D. net capital spending.
E. cash flow from assets.

Cash Flow from Assets

For a tax-paying firm, an increase in _____ will cause the cash flow from assets to increase.
A. depreciation
B. change in net working capital
C. net capital spending
D. taxes
E. production costs

Deprecation

You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You are planning on investing in an account which will pay 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire?

I. Invest in a different account paying a higher rate of interest.
II. Invest in a different account paying a lower rate of interest.
III. Retire later.
IV. Retire sooner.

A. I and IV only
B. II and III only
C. I and III only
D. II only
E. I only

I and III only

Which of these important relationships are true?
I: For a given interest rate - the longer the time period, the higher the future value
II: For a given interest rate - the longer the time period, the higher the present value
III: For a given time period - the higher the interest rate, the lower the future value
IV: For a given time period - the higher the interest rate, the lower the present value
A. I, II, III, and IV
B. II and IV only
C. II and III only
D. I and III only
E. I and IV only

I and IV only

All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.
A. a discount; less than
B. a discount; higher than
C. par; less than
D. a premium; less than
E. a premium; equal to

a discount; less than

The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?
A. decrease the market price
B. increase the market price
C. increase the coupon rate
D. decrease the coupon rate
E. increase the time period

decrease the market price

The mixture of debt and equity used by a firm to finance its operations is called:

A. agency cost analysis.
B. financial depreciation.
C. capital budgeting.
D. capital structure.
E. working capital management.

Capital Structure

Which one of the following is a capital budgeting decision?
A. determining how many shares of stock to issue
B. deciding how to refinance a debt issue that is maturing
C. determining how much inventory to keep on hand
D. determining how much money should be kept in the checking account
E. deciding whether or not to purchase a new machine for the production line

deciding whether or not to purchase a new machine for the production line

Which one of the following is a capital structure decision?
A. determining which one of two projects to accept
B. determining how much debt should be assumed to fund a project
C. determining how much inventory will be needed to support a project
D. determining how to allocate investment funds to multiple projects
E. determining the amount of funds needed to finance customer purchases of a new product

determining how much debt should be assumed to fund a project

Which one of the following is a working capital management decision?
A. determining the amount of long-term debt required to complete a project
B. determining the number of shares of stock to issue to fund an acquisition
C. determining whether to pay cash for a purchase or use the credit offered by the supplier
D. determining the amount of equipment needed to complete a job
E. determining whether or not a project should be accepted

determining whether to pay cash for a purchase or use the credit offered by the supplier

The primary goal of a publicly-owned firm interested in serving its stockholders should be to:
A. maximize share price.
B. minimize expected EPS.
C. minimize the chances of losses.
D. minimize shareholder wealth.
E. maximize expected total corporate profit.

Maximize share price

Which term relates to the cash flow which results from a firm's ongoing, normal business activities?
A. cash flow from assets
B. operating cash flow
C. net working capital
D. capital spending
E. cash flow to creditors

Operating cash flow

An increase in which of the following will increase the return on equity, all else constant?
I. sales
II. net income
III. depreciation
IV. total equity

A. I, II, and III only
B. II and III only
C. I and II only
D. I only
E. II and IV only

I and II only

A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond?
I. discounted price
II. premium price
III. yield-to-maturity that exceeds the coupon rate
IV. yield-to-maturity that is less than the coupon rate

A. III only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only

II and IV

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. warrant
B. debenture
C. common stock
D. preferred stock
E. senior bond

Preferred stock

National Trucking has paid an annual dividend of $1.00 per share on its common stock for the past fifteen years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm's stock is:
A. equal in value to the present value of $1 paid one year from today.
B. worth $1 a share in the current market.
C. basically worthless as it offers no growth potential.
D. valued at an assumed growth rate of one percent.
E. priced the same as a $1 perpetuity

Priced the same as a $1 perpetuity

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:
A. structured cost of capital.
B. subjective cost of capital.
C. weighted capital gains rate.
D. reward to risk ratio.
E. weighted average cost of capital.

weighted average cost of capital.

The capital structure weights used in computing the weighted average cost of capital:
A. remain constant over time unless the firm issues new securities.
B. are based on the market value of the firm's debt and equity securities.
C. are computed using the book value of the long-term debt and the book value of equity.
D. are restricted to the firm's debt and common stock.
E. are based on the book values of total debt and total equity.

are based on the market value of the firm's debt and equity securities.

Most loans are a form of a(n)

annuity

Decreasing the required rate of return will ________ the net present value of a project.

A. increase
B. Decrease

Increase

A decision to issue additional shares of stock is what kind of decision?

Capital structure decision

For a given time period, the higher the interest rate, the smaller the _________

present value

For a given interest rate, the higher the ______, the lower the present value

future value

What is a bond call option?

it gives the company the right to call or purchase the bonds at a specified price from bondholders

What is the yield-to-maturity of a bond?

a bondholders required rate of return for holding a bond. it is the current required market rate.

If the coupon is higher than the YTM then it is a ____ bond

Discount

What is a common shareholder entitled to?

voting, share in profits, residual assets in a liquidation

Advantages of payback

liquidity basis, ease of use, adjusts for uncertainty of later cash flows

Disadvantages of payback

requires cut off point, biased against long term projects, and ignores time value money

Advantages of discounted payback

includes time value money, easy to understand, biased towards liquidity

Disadvantages of discounted payback

requires cut off point, ignores cash flows beyond cut off point and may reject positive NPV investments.

Advantages of Account rate of return

easy to calculate, and needed information will usually be available

Disadvantages of Account rate of return

exclusion of time value of money, need a cut off rate and based on accounting values

Advantages of Profitability index

easy to understand and communicate, useful when investment funds are limited

Disadvantages of Profitability index

leads to incorrect decisions in comparison of mutually exclusive investments

Side effects (positive and negative)

positive: benefits to other projects
Negative: costs to other projects

should operating cash flows be pre tax or after tax?

after tax

What is the capital asset pricing model and what does it measure?

it defines the relationship between risk and return. We can use the CAPM to determine its expected return, and expected equity on return.

What two models can estimate the cots of equity?

Capital asset pricing model and dividend growth model

What are the two ways to estimate the growth in dividends?

historical growth and analysts' forecast

How do you measure the cost of debt? is it equal to the coupon outstanding company debt?

yield to maturity // not the coupon rate

Which components of the capital structure is adjusted for taxes and why?

Debt is adjusted for taxes because, only interest is tax deductible. Companies are not allowed to adjust dividends.

In calculating the weighted average cost of capital do you use the market value or the book value?

Market value

If you one of the models and compare a cost of equity to be less than the cost of debt does this make sense?

No, because equity should have a higher return and debt since, it carries more risk to the holder.

What are you trying to minimize/maximize when you select a debt- equity ratio?

you want to minimize the cost of capital

As the firms risk increases, the cost of capital _______ and the NPV of projects __________

cost of capital INCREASES and the NPV of projects DECREASE

What does beta measure?

beta measures the systematic risk of market risk which cannot be divorced away. The risk you can't get rid of such as things that impact all companies or economic downturns

If you were calculating a worst case scenario would you use high or low costs?

In calculating the worst case scenario you would use high costs and low revenue and vise versa for best case scenario.

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is called the:
a. mean.
B. beta coefficient.
c. risk premium.
d. standard deviation.
e. variance.

Beta Coeffiecient

The return on a risky asset that is anticipated in the future is called the:
a. real return.
b. risk premium.
c. systematic return.
D. expected return.
e. beta.

Expected Return

Which of the following will increase the sustainable growth rate of a firm?
I. eliminating all dividends
II. increasing the target debt-equity ratio
III. increasing the profit margin
IV. increasing the total asset turnover rate
a. I, III, and IV only
B. I, II, III, and IV
c. I, II, and III only
d. I and II only
e. II, III, and IV only

I, II, III and IV

Which one of the following is the preferred method of analyzing a proposed investment?
a. payback
B. net present value
c. internal rate of return
d. profitability index
e. accounting rate of return

Net present value

A net present value of zero implies that an investment:
A. is earning a return that exactly matches the requirement.
b. has no initial cost.
c. never pays back its initial cost.
d. should be rejected even if the discount rate is lowered.
e. has an expected return that is less than the required return.

Is earning a return that exactly matches the requirement

Systematic risk is:
a. also called diversifiable risk.
b. unique to an individual firm.
c. also called asset-specific risk.
d. the total risk inherent in an individual security.
E. a risk that affects a large number of assets.

A risk that affects a large number of assets

The discount rate that causes the net present value of a project to equal zero is called the:
a. average accounting return.
b. market rate.
C. internal rate of return.
d. yield to maturity.
e. required return.

Internal rate of return

The concept of investing in a variety of diverse assets to reduce risk is referred to as:
A. the principle of diversification.
b. beta measuring.
c. the systematic risk principle.
d. the principle of elimination.
e. split investing.

The principle of diversification

The change in a firm's future cash flows that results from adding a new project are referred to as _____ cash flows.
a. direct
b. deviated
C. incremental
d. eroded
e. residual

Incremental

Which of the following will increase the net income of a profitable firm?
I. decreasing the depreciation
II. increasing the variable cost per unit
III. decreasing fixed costs
IV. increasing revenue
a. III and IV only
b. I, II, and III only
C. I, III, and IV only
d. I and IV only
e. II, III, and IV only

I, III, and IV

A situation in which taking one investment prevents the taking of another is called:
A. Net present value profiling.
B. Operational ambiguity.
C. Mutually exclusive investment decisions.
D. Issues of scale.
E. Multiple rates of return.

Mutually exclusive investment decisions

A conventional cash flow is defined as a series of cash flows where:
A. The total of the cash flows is positive.
B. All of the cash flows are positive.
C. The sum of the cash flows is equal to zero.
D. The present value of the cash flows is equal to zero.
E. Only the initial cash flow is negative.

Only the initial cash flow is negative

Which of the following decision rules has the advantage that the information needed for the computation is readily available?

A. Net present value
B. Internal rate of return
C. Payback period
D. Average accounting return
E. Discounted payback

Average Accounting Return

Which of the following calculations takes the time value of money into account?
I. Payback
II. Average accounting return
III. Profitability index

III only

The payback rule can be best stated as:
A. An investment is acceptable if its calculated payback period is less than some prespecified number of years.
B. An investment should be accepted if the payback is positive and rejected if it is negative.
C. An investment should be rejected if the payback is positive and accepted if it is negative.
D. An investment is acceptable if its calculated payback period is greater than some pre-specified number of years.

An investment is acceptable if its calculated payback period is less than some prespecified number of years.

Diversification works because:
I. Unsystematic risk exists.
II. Forming stocks into portfolios reduces the standard deviation of returns for each stock.
III. Firm-specific risk can be dramatically reduced if not eliminated
A. I only
B. I and III only
C. I and II only
D. III only
E. I, II, and III

I and III

The CAPM shows that the expected return for a particular asset depends on:
I. The amount of unsystematic risk.
II. The reward for bearing systematic risk.
III. The pure time value of money.
A. I only
B. I and II only
C. III only
D. I, II, and III
E. II and III only

II and III

Which of the following does NOT describe the risk that exists in a well-diversified portfolio?
A. Asset-specific risk
B. Market risk
C. Non-diversifiable risk
D. Systematic risk

Asset-specific risk

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