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finance final mc questions
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Terms in this set (58)
Promised future cash flows are not known in advance; there is no finite end-point to the cash flows.
Why are common stocks harder to value than bonds?
value of a stock
______ is the present value of the future dividends expected to be generated by the stock.
earnings
Dividends grow proportionate to ___________
P hat = D/rs
What is the formula for zero-dividend growth model?
rs>g; g is expected to be constant forever
The constant growth model can only be used if:
P hat 1 = P0 (1+g)
what is another way (formula) to find P hat 1 other than using the CGM formula?
rs= (D1/P0) + g
what is the formula to find rs using CGM?
YTM
what is the expected rate of return the same as?
dividend yield plus the capital gains yield
what does the expected rate of return equal?
corporate valuation methodology; valuation using P/E ratio
what are two other valuation techniques aside from the ones we have used?
corporate valuation methodology.
This valuation method is for stocks that do not pay dividends or have erratic dividend growth
maximize shareholder value
what is the primary goal of a corporation?
long-term debt; preferred stock; common equity
what sources of long term capital do firms use?
$100
what is the par value of preferred stock usually assumed to be?
shareholder value
the long run value of a firm's stock
interest is tax deductible
why is rd the only one that needs adjustment in terms of tax?
new capital
the cost of capital is used primarily to make decisions that involve raising _____________
marginal
should analysis of WACC focus on historical or marginal costs?
rd
the interest rate on the firm's debt
rp
marginal cost of preferred stock; The rate of return investors require on the firm's preferred stock.
rs
the marginal cost of common equity using either retained earnings or new equity issued
rs
The rate of return investors require on the firm's common equity. Also can be considered the cost of retained earnings
RF + (RM-RF)B
what is the CAPM SML formula for rs?
flotation costs
costs that depend on the risk of the firm and the type of capital being raised.
common equity
flotation costs are highest for...?
rises
when interest rates go up, rd does what?
rises
when stock prices go down, rs does what?
capital structure and dividend policy; firm's investment policy
what are factors that a firm can control?
interest rates, general level of stock prices, tax rates
what is out of a firm's control?
Make their debt (bonds) bigger because bonds are the least risky.
If a company wants to lower WAAC, the could do what?
higher WAAC
Higher risk generally means what in terms of WAAC?
WACC
reflects the risk of an average project undertaken by the firm
capital budgeting
analysis of potential additions of fixed assets; long term decisions involving large expenditures
when greater than 0
what do you accept in terms of NPV?
when IRR is greater than required rate of return
when do you accept in terms of IRR?
independent projects
if the cash flows of one project are unaffected by the acceptance of the other.
Mutually exclusive projects
if the cash flows of one project can be adversely impacted by the acceptance of the other.
payback period
Calculated by adding project's cash inflows to its cost until the cumulative cash flow for the project turns positive.
indication of liquidity; easy to calculate/understand
what are the strengths of payback period?
ignore time value of money; ignores CFs occuring after payback period; biased towards short term projects; cut off period is arbitrary
what are the weaknesses of payback period?
net present value
Difference between the market value of an investment and its cost, i.e. difference between the PV of future cash flows and the initial cost.
NPV
Net addition to the value of the firm (in terms of dollars) by completing this project.
IRR is equal to WACC
when cash flows are just sufficient to provide investors with their required rates of return.
no
is IRR dependent on the required rate of return (cost of capital)
no, due to scale and timing problems
does higher IRR always mean higher NPV?
essentially cancel
At very low discount rates, the PV's of CF1 and CF2 _____________, so NPV < 0.
small
At very high discount rates, the PV's of CF1 and CF2 are ________________, so CF0 dominates and again NPV < 0.
y-intercepts
larger projects have bigger _______
required rate of return or the opportunity cost of capital
NPV methods assumes CFs are reinvested at the ____________
IRR
IRR method assumes CFs are reinvested at _________
incremental cash flows
The only relevant cash flows for a project are ____________
incremental cash flows
Any and all changes in a firm's future cash flows that are a direct result of taking the project.
opportunity cost
Cost of an alternative that is not pursued
externalities
The effects of the new project on the cash flow from the existing projects of the firm.
sunk costs
Cash flow that occurs regardless of whether you accept this project or not; Costs that have already been paid or liabilities that have been incurred.
increase depreciation earlier on for projects; make accelerated depreciation more accelerated
what can you do to depreciation to increase capital expenditure?
higher NPVs
Higher OCFs will result in...?
lower early tax payments; higher early OCFs; higher NPVs
what will increasing depreciation earlier on or accelerating it do?
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