# Shared Flashcard Set

## Details

FIN 6003 Test II
Finance ch 8-15
69
Finance
12/02/2019

Term
 A certain project requires an immediate cash outflow of \$4 million. At the end of each of the next four years, the investment will generate cash inflows of \$1.5 million. That is, it at the end of each years, 1st, 2nd, 3rd, and 4th year, the cash inflow is \$1.5 million.Inflation rate is expected to be 5% per year during the next four year period.Assuming the cash flows are in nominal terms, what will be the project's NPV if you required 5% real rate of return?
Definition
 \$0.7292 millionWe need to either discount nominal dollars by nominal rates or real dollars (adjusted for inflation) by real rates. Nominal rat= (1+real rate)(1+inflation rate)-1nominal rate= (1.05)(1.05)-1=1.1025-1=0.1025 or 10.25% nominal rate.CF0= - 4, CF1 through CF4 =1.5, I=10.25, NPV=0.7292
Term
 he human element in capital budgeting process refers to the human capital (employee skills and capacity) to take on the positive NPV projects. Otherwise, even the best positive NPV projects may become a failure and loss for the firm.TrueFalse
Definition
 True
Term
 A certain project requires an immediate cash outflow of \$4 million. At the end of each of the next four years, the investment will generate cash inflows of \$1.5 million. That is, it at the end of each years, 1st, 2nd, 3rd, and 4th year, the cash inflow is \$1.5 million.Assuming the cash flows are in nominal terms, what will be the project's NPV at 10.25% nominal discount rate?
Definition
 \$0.7292 millionCF0= -4, CF1=1.5, CF2=1.5, CF3=1.5, CF4=1.5, I=10.25%, NPV=0.7292ORN=4, PMT=1.5, FV=0, I/Y=10.25, CPT PV=4.7292 and subtract the initial outlay of 4
Term
 If you discounted a set of positive real cash flows with a nominal discount rate and inflation were positive, you would __________ the present value of those cash flows.underestimateoverestimatecorrectly calculateIt depends on other factors.
Definition
 underestimate
Term
 Which of the two projects are most likely superior?Project A: NPV= \$1 million at 10% discount rate with equal cash inflows; length of the project is 5 years.Project B: NPV=\$2 million, at 10% discount rate with equal cash inflows; length of the project is 20 years.Project AProject B
Definition
 Project AProject, although has a lower NPV, is superior because of its length. In 5 years, time it brings in a net value of \$1m, that is approximately \$200k net value per year.Project B brings in \$2 m, but takes 20 years, that is 4 times as long as project A.It's per year NPV is approximately \$100k per year which is inferior to \$200k of project A.
Term
 largest non-cash item for most investment projects
Definition
 depreciation
Term
 accelerated form of depreciation
Definition
 MACRS
Term
 equals the % of taxes owed on an incremental dollar of income
Definition
 marginal tax rate
Term
 equals the difference between current assets and current liabilities
Definition
 working capital
Term
 value of a project at a given future point in time
Definition
 terminal value
Term
 When project cash flows are stated in real terms, the proper discount rate to use in calculating the NPV is the __________.inflation rateCorrect real rateterminal ratemarginal tax ratenone of the above
Definition
 real rate
Term
 the situation where sales of a new product come at the expense of a firm's existing products
Definition
 Cannibalization
Term
 the equal, annual expenditure over the life of a project that yields the project's NPV
Definition
 Equivalent Annual Cost
Term
 a number intended to reflect the value of a project at a given future point in time
Definition
 Terminal Value
Term
 the cash flows on the alternative investment that the firm decides not to make
Definition
 Opportunity Costs
Term
 Tanya believes noncash expenses should be ignored when making capital budgeting decisions because they have no impact on cash flows. She is mistaken because:noncash expenses increase net income and must be added back to appropriately calculate cash flowsnoncash expenses decrease the cost of goods sold and therefore increase cash flowsnoncash expenses reduce taxable income, decrease tax payments, and increase cash flowsnoncash expenses (such as depreciation) allow a firm to spread the cost of fixed assets over many years and therefore balance cash outflowsnoncash expenses increase net working capital and therefore are cash outflows
Definition
 noncash expenses reduce taxable income, decrease tax payments, and increase cash flows
Term
 Why is accelerated depreciation (MACRs) useful for a firm?Since depreciation is not a cash flow, it is not useful, merely required by the tax codeAccelerating the depreciation reduces book value; increasing book-value based return ratiosMACRs is consistently applied in other countriesMACRS reduces taxes and increases cash flow
Definition
 MACRS reduces taxes and increases cash flow
Term
 You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 13.25%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley's WACC? (Hint: Note that the cost of debt, the interest, is tax deductible, but preferred stock and common stock costs are not.)11.20%9.99%9.16% 9.25%9.44%
Definition
 9.25%
Term
 Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: Beta of the company is 1.5; current risk-free rate is 3% and the market rate is 10.2467%. If the company uses its retained earnings, what will be the cost of capital for the company based on CAPM? (Note that although the company doesn't have to pay anyone when it uses its retained earnings, there is still an implicit cost equal to the amount stockholders typically require based on the beta of the company.)13.45% 13.87%15.53%16.50%13.03%
Definition
 13.87%Use CAPM: required rate=risk free rate + beta* (market rate - risk free rate)=3+1.5(10.2467-3)
Term
 Bosio Inc.'s perpetual preferred stock sells for \$75.00 per share, and it pays an \$8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors (or \$3, which is 0.04x\$75). What is the company's cost of preferred stock for use in calculating the WACC? (Note that the company raises \$72 from proceeds of selling new shares at \$75 due to the flotation (transaction) cost. 0.39%13.93%14.40%14.28% 11.81%
Definition
 11.81%Response Feedback: Preferred stock price \$75.00Preferred dividend \$8.50Flotation cost 4.00%
Term
 You were recently hired by Scheuer Media Inc. to estimate its cost of capital. The company finances its assets by 50% debt and 50% equity. The interest on its debt is 7.84% while equity investors typically require 12%. The company is subject to 25% effective tax. What is the WACC for the company? (note that only the cost of debt is tax deductible)11.08%8.49%9.21% 8.94%6.97%
Definition
 8.94%WACC= 0.5x7.84x(1-0.25)+0.5x12
Term
 Rivoli Inc. hired you as a consultant to help estimate its cost of equity. You estimate the beta of the company at 1 and the current risk-free rate and the market rate at 2% and 10% respectively. What is the approximate cost of equity for the company?11.34%8.00% 10.00%9.13%12.24%
Definition
 10.00%
Term
 "Capital" is sometimes defined as funds supplied to a firm by investors.TrueFalse
Definition
 True
Term
 A company's capital structure is 40% debt and 60% equity. The interest cost on its debt is 10% and its cost of equity is 12%. The company is subject to 24.75% effective tax rate. what is the WACC for the company?9.60%7.66%11.33%8.37% 10.21%
Definition
 10.21%Response Feedback: = 0.4x10%x(1-0.2475)+0.6x12%
Term
 Assume that you are a consultant to Broske Inc., and you have been provided with the following data: The company pays a fixed annual dividend of \$4.8 per share and its current stock price is \$50. The company is operating in a mature industry and not expected to grow at all. What is the cost of equity for the company?11.30%9.58%9.96%11.68%7.95%
Definition
 9.58%the company pays 4.8 per 50 worth of its stocks. so the cost for the company is 4.8/50
Term
 You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 13.00%. The firm will not be issuing any new stock. What is its WACC?9.38%11.44%9.19%7.22%10.22%
Definition
 9.38%
Term
 O'Brien Inc. has the following data: risk free rate = 5.00%; market rate = 11.00%; and beta = 1.10. What is the firm's cost of equity from retained earnings based on the CAPM?11.83%13.22%11.25%8.93% 11.60%
Definition
 11.60%Response Feedback: rRF 5.00%RPM 6.00%b 1.10
Term
 Moe’s has a current stock price of \$90. The company announced a new product at 11:00 am Wednesday which the market had no knowledge of prior to the announcement. If the NPV per share of the project is \$2 and the market agrees with this, what will the price be at 11:01 am Wednesday, if this is an efficient market?\$88\$90\$92\$85
Definition
 \$92=90+2
Term
 Assume that markets are semi-strong form efficient. Suppose, then, that during a trading day, important new information is released for the first time concerning a certain company. This information indicates that one of the firm's oil fields, previously thought to be very promising, just came up dry. How would you expect the price of a share of stock to react to this information?The value of a share will fall over an extended period of time as investors begin to sell shares in the companyThe value of a share will drop immediately to a price that reflects the value of the new information.The value of a share will fall below what is considered appropriate because of the decreased demand for the shares, but eventually the price will rise to the correct level.The stock price will not change, since this type of information has no impact in markets that are semi-strong form efficient.
Definition
 The value of a share will drop immediately to a price that reflects the value of the new information.
Term
 Which of the following countries tend to have the lowest mutual fund feesCountries with high investor protectionCountries with high inside informationCountries with poorly developed capital marketsCountries geographically close to the United States
Definition
 Countries with high investor protection
Term
 In markets characterized by __________, asset prices reflect all information, public and private.weak-form efficiencysemistrong-form efficiencystrong-form efficiencyrandom walkbehavioral finance
Definition
 strong-form efficiency
Term
 If inside information has value, the _______ form of market efficiency is violatedWeakSemi-weakStrongSemi-strong
Definition
 Strong
Term
 _________ uses insights from psychological research.Behavioral financeThe efficient markets hypothesisTechnical analysisInformational efficiencyA noise trader
Definition
 Behavioral finance
Term
 In a strong-form efficient market, accounting announcements:will impact stock price only if it is related to cash flowswill impact stock price if it involves new public informationwill impact stock price if it affects a firm's ability to borrow fundswill not impact stock priceb and c
Definition
 will not impact stock price
Term
 If stock returns follow a random walk, you should:employ a mean reversion investment trading strategybase trades on recurring patterns in stock pricesnot attempt to find a predictable pattern in stock returnsemploy an industry-based momentum trading strategyall of the above
Definition
 not attempt to find a predictable pattern in stock returns
Term
 According to behaviorists, noise traders affect prices in financial markets by:trading on beliefs not fully justified by fundamental newsdecreasing the risk for rational investors who might otherwise trade against themcreating riskless arbitrage opportunities for more informed tradersseeking to exploit small pricing irregularities when a stock is undervalued or overvaluedassessing true risks and expected returns on all securities
Definition
 trading on beliefs not fully justified by fundamental news
Term
 For technical analysis, based on patterns of historical prices, to have value, ______ form of market efficiency must be violated WeakSemi-weakStrongSemi-strong
Definition
 Weak
Term
 The dominant source of financing in the United States isInternal cash from operationsBondsPreferred stockCommon stock
Definition
 Internal cash from operations
Term
 The order of priority for claims if a firm must be liquidated is:preferred stock, senior debt, subordinated debt, common stockpreferred stock, common stock, senior debt, subordinated debtsenior debt, preferred stock, subordinated debt, common stocksenior debt, subordinated debt, preferred stock, common stocknone of the above
Definition
 senior debt, subordinated debt, preferred stock, common stock
Term
 What does LIBOR stand for?London Institutional Borrowing Outstanding ReturnLondon Inter-Bank Offered RateLondon International Banking Organizational RuleLondon Interest By Other Returns
Definition
 London Inter-Bank Offered Rate
Term
 Convertible bonds:allow the firm to convert existing bonds to common shares at some future dateallow the investor to convert their bonds to common shares at some future dateallow the firm to convert the bond interest to a new par basisallow the investor to convert their bond interest to a new par value basisnone of the above
Definition
 allow the investor to convert their bonds to common shares at some future date
Term
 External funding needs tend to __________ at the end of economic expansion and __________ during recessions.peak; bottom outbottom out; peakpeak; peakbottom out; bottom outnone of the above
Definition
 peak; bottom out
Term
 Which of the following legal traditions offers the weakest protection to outside investors?German LawScandinavian LawFrench Civil LawEnglish Common Law
Definition
 French Civil Law
Term
 The phrase “residual claimant” is often applied todebtholderscommon stockholdersthe lawyer representing creditors at a bankruptcy hearinga party that is able to purchase firm assets at cheap prices due to a hasty liquidation
Definition
 common stockholders
Term
 In countries with legal systems based on English common law:greater protection is afforded to minority shareholders and public equity markets are larger than in countries with other legal systemsgreater protection is afforded to shareholders and creditors, resulting in decreased tendencies towards entrepreneurshippublic equity markets are larger than in countries with other legal systems but entrepreneurial tendencies are relatively lowentrepreneurship tendencies are higher due to low expected bankruptcy costsmarkets are characterized by atomistic ownership structures where a single investor or a single block of shareholders is likely to control a majority of the voting stock in the typical public company
Definition
 greater protection is afforded to minority shareholders and public equity markets are larger than in countries with other legal systems
Term
 Callable bonds allow the issuing entity the opportunity to retire the issue prior to maturity. When is a bond most likely to be called?When the issuing entity has lower working capital.When market interest rates have decreased.When the issuing entity has excess cash.When the issuing entity has an excess of Treasury stock on the books that can be used to replace the callable bonds.When the issuing entity's bondholders are disgruntled with the firm after interest rate increases.
Definition
 When market interest rates have decreased.
Term
 The primary instruments used for long-term financing include all of the following except:commercial papercommon stockpreferred stocklong term debtall of the above
Definition
 commercial paper
Term
 When M & M assume that capital markets are frictionless it means __________.no taxesno transaction costsinvestors can borrow and lend at the same rate that corporations canall of the abovenone of the above
Definition
 all of the above
Term
 If a firm has \$6.5 million in debt, \$27.8 million in equity, a tax rate of 35%, and pays 7% interest on debt, what is the firm's value of the interest tax shields?\$202200\$327200\$8.5 million\$2.275 million\$418910
Definition
 \$2.275 millionPV interest tax shields = Tc D= 0.35(\$6.5m)= \$2.275m
Term
 Financial leverage:Increases expect EPS and Increases EPS volatilityIncreases expect EPS and Decreases EPS volatilityDecreases expect EPS and Increases EPS volatilityDecreases expect EPS and Decreases EPS volatility
Definition
 Increases expect EPS and Increases EPS volatility
Term
 Which of the following type companies is the least likely to have debt in their capital structure?Automobile ManufacturingHigh-techFood ChainRetailing
Definition
 High-tech
Term
 capital structure is the result of market timing
Definition
 managerial opportunism theory
Term
 firms balance costs and benefits of debt
Definition
Term
 firm value does not depend on capital structure
Definition
 M&M theory
Term
 M & M Proposition II says that the WACC is not influenced by changing the mix of debt and equity because changes in leverage cause an offsetting change in the __________.WACCrequired return on equitytarget leverage zonessecured debt hypothesisnone of the above
Definition
 required return on equity
Term
 In attempting to develop a model, M & M showed that capital structure could not affect the firm value in a world with __________.perfect marketstarget leverage zoneshomemade leveragearbitragenone of the above
Definition
 perfect markets
Term
 Firms in the __________ industry(ies) use a great deal of debt.TechnologyPharmaceuticalSoftware Utility
Definition
 Utility
Term
 PureMeds is a highly profitable pharmaceutical company that places great importance on funding research and development projects. According to finance research, the expected capital structure for PureMeds:would show a high market-value leverage levelwould show a high book-value leverage levelwould contain a high long-term debt levelwould contain a high total debt levelwould show a low financial leverage level
Definition
 would show a low financial leverage level
Term
 According to M&M’s Proposition II the expected return on a levered firm’s equity:Falls to the debt-to-equity ratioThe levered firm’s equity expect return does not change with the debt-to-equity levelRises with the debt-to-equity ratioRises with the debt-to-equity ratioProposition II does not address the leveraged firm’s expected return on equity
Definition
 Rises with the debt-to-equity ratio
Term
 For a typical cash dividend, which is correct chronological order?Payment date; record date; ex-dividend dateEx-dividend date; record date; payment dateRecord date; ex-dividend date; payment dateRecord date; payment date; ex-dividend date
Definition
 Ex-dividend date; record date; payment date
Term
 Logically stock splits ________ create value, empirically stock splits________ do create value. Should; doShould; do notShould not; doShould not; do not
Definition
 Should not; do
Term
 The agency theory that best explains the dividend behavior or large mature firms generating substantial free cash flow:The M&M Irrelevancy theoryThe catering theoryThe signaling modelThe agency/contracting model
Definition
 The agency/contracting model
Term
 According to the agency cost model of dividend policy, a firm with large amounts of free-cash flow, few positive-NPV investment opportunities, and numerous shareholders would be expected to have:a constant payout ratio dividend policya low-regular-and-extra dividend policya high dividend payout levela low dividend payout levelan undeterminable dividend payout level
Definition
 a high dividend payout level
Term
 If a country's tax laws change such that capital gains and dividends are taxed at the same rate each and every period (and if paid-in-capital as a capital gains basis were very small), then:corporate dividend payout ratios will fallfirms will payout all earnings in dividends rather than retain earningscorporate dividend payout ratios will be irrelevantfirms will retain all earnings rather than pay dividendsfirms will increase the usage of share repurchase programs
Definition
 corporate dividend payout ratios will be irrelevant
Term
 Almost-gone is on the verge of being delisted from Nasdaq because its share price has dropped below the \$1 per share minimum. Management would most likely undertake:a 2-for-1 splita 1-for-2 splita share repurchase programa stock dividend programthe payment of an extra dividend
Definition
 a 1-for-2 split
Term
 One reason financial managers of a firm would use a reverse stock split is:To increase the firm’s shares outstanding.To reverse an increasing price trend with the firm's stock to bring it back to an affordable range for most investors.To reduce the cost of capital with fewer shares outstanding.To increase the stock price to keep the stock eligible for continued exchange trading.To purchase additional shares to have in-house to use in a merger.
Definition
 To increase the stock price to keep the stock eligible for continued exchange trading.
Term
 The __________ is the actual date on which the firm mails the dividend payment to the holder of record.announcement datepayment daterecord dateex-dividend dateshareholders of record date
Definition
 payment date
Term
 Paying dividends when investors assign a premium to dividend paying stocks is associated withThe dividend premium theoryThe catering theoryThe signaling modelThe agency/contracting model
Definition
 The catering theory
Term
 Which of the following best describes the empirical evidence regarding dividends?Taxes influence dividends, firms manage dividends, and most firms do not pay dividendsTaxes influence dividends, dividends are residual, most firms pay dividendsTaxes influence dividends, firms manage dividends, most firms pay dividendsTaxes influence dividends, dividends are residual, and most firms do not pay dividends
Definition
 Taxes influence dividends, firms manage dividends, and most firms do not pay dividends
Supporting users have an ad free experience!