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? |
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Definition
$0.7292 million
We 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)-1
nominal 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 |
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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.
True
False |
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Definition
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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? |
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Definition
$0.7292 million
CF0= -4, CF1=1.5, CF2=1.5, CF3=1.5, CF4=1.5, I=10.25%, NPV=0.7292
OR
N=4, PMT=1.5, FV=0, I/Y=10.25, CPT PV=4.7292 and subtract the initial outlay of 4 |
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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.
underestimate
overestimate
correctly calculate
It depends on other factors. |
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Definition
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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 A
Project B |
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Definition
Project A
Project, 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. |
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Term
| largest non-cash item for most investment projects |
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Definition
|
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Term
| accelerated form of depreciation |
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Definition
|
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Term
| equals the % of taxes owed on an incremental dollar of income |
|
Definition
|
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Term
| equals the difference between current assets and current liabilities |
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Definition
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Term
| value of a project at a given future point in time |
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Definition
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Term
When project cash flows are stated in real terms, the proper discount rate to use in calculating the NPV is the __________.
inflation rate
Correct real rate
terminal rate
marginal tax rate
none of the above |
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Definition
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Term
| the situation where sales of a new product come at the expense of a firm's existing products |
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Definition
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Term
| the equal, annual expenditure over the life of a project that yields the project's NPV |
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Definition
|
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Term
| a number intended to reflect the value of a project at a given future point in time |
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Definition
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Term
| the cash flows on the alternative investment that the firm decides not to make |
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Definition
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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 flows
noncash expenses decrease the cost of goods sold and therefore increase cash flows
noncash expenses reduce taxable income, decrease tax payments, and increase cash flows
noncash expenses (such as depreciation) allow a firm to spread the cost of fixed assets over many years and therefore balance cash outflows
noncash expenses increase net working capital and therefore are cash outflows |
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Definition
| noncash expenses reduce taxable income, decrease tax payments, and increase cash flows |
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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 code
Accelerating the depreciation reduces book value; increasing book-value based return ratios
MACRs is consistently applied in other countries
MACRS reduces taxes and increases cash flow |
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Definition
| MACRS reduces taxes and increases cash flow |
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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% |
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Definition
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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% |
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Definition
13.87%
Use CAPM: required rate=risk free rate + beta* (market rate - risk free rate)
=3+1.5(10.2467-3) |
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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
$75.00
Preferred dividend
$8.50
Flotation cost
4.00% |
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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 |
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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% |
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Definition
|
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Term
"Capital" is sometimes defined as funds supplied to a firm by investors.
True
False |
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Definition
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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% |
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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 |
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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% |
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Definition
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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 |
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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 |
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Definition
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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 company
The 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. |
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Definition
| The value of a share will drop immediately to a price that reflects the value of the new information. |
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Term
Which of the following countries tend to have the lowest mutual fund fees
Countries with high investor protection
Countries with high inside information
Countries with poorly developed capital markets
Countries geographically close to the United States |
|
Definition
| Countries with high investor protection |
|
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Term
In markets characterized by __________, asset prices reflect all information, public and private.
weak-form efficiency
semistrong-form efficiency
strong-form efficiency
random walk
behavioral finance |
|
Definition
|
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Term
If inside information has value, the _______ form of market efficiency is violated
Weak
Semi-weak
Strong
Semi-strong |
|
Definition
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|
Term
_________ uses insights from psychological research.
Behavioral finance
The efficient markets hypothesis
Technical analysis
Informational efficiency
A noise trader |
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Definition
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Term
In a strong-form efficient market, accounting announcements:will impact stock price only if it is related to cash flows
will impact stock price if it involves new public information
will impact stock price if it affects a firm's ability to borrow funds
will not impact stock price
b and c |
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Definition
| will not impact stock price |
|
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Term
If stock returns follow a random walk, you should:
employ a mean reversion investment trading strategy
base trades on recurring patterns in stock prices
not attempt to find a predictable pattern in stock returns
employ an industry-based momentum trading strategy
all of the above |
|
Definition
| not attempt to find a predictable pattern in stock returns |
|
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Term
According to behaviorists, noise traders affect prices in financial markets by:
trading on beliefs not fully justified by fundamental news
decreasing the risk for rational investors who might otherwise trade against them
creating riskless arbitrage opportunities for more informed traders
seeking to exploit small pricing irregularities when a stock is undervalued or overvalued
assessing true risks and expected returns on all securities |
|
Definition
| trading on beliefs not fully justified by fundamental news |
|
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Term
For technical analysis, based on patterns of historical prices, to have value, ______ form of market efficiency must be violated
Weak
Semi-weak
Strong
Semi-strong |
|
Definition
|
|
Term
The dominant source of financing in the United States is
Internal cash from operations
Bonds
Preferred stock
Common stock |
|
Definition
| Internal cash from operations |
|
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Term
The order of priority for claims if a firm must be liquidated is:
preferred stock, senior debt, subordinated debt, common stock
preferred stock, common stock, senior debt, subordinated debt
senior debt, preferred stock, subordinated debt, common stock
senior debt, subordinated debt, preferred stock, common stock
none of the above |
|
Definition
| senior debt, subordinated debt, preferred stock, common stock |
|
|
Term
What does LIBOR stand for?
London Institutional Borrowing Outstanding Return
London Inter-Bank Offered Rate
London International Banking Organizational Rule
London 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 date
allow the investor to convert their bonds to common shares at some future date
allow the firm to convert the bond interest to a new par basis
allow the investor to convert their bond interest to a new par value basis
none of the above |
|
Definition
| allow the investor to convert their bonds to common shares at some future date |
|
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Term
External funding needs tend to __________ at the end of economic expansion and __________ during recessions.
peak; bottom out
bottom out; peak
peak; peak
bottom out; bottom out
none of the above |
|
Definition
|
|
Term
Which of the following legal traditions offers the weakest protection to outside investors?
German Law
Scandinavian Law
French Civil Law
English Common Law |
|
Definition
|
|
Term
The phrase “residual claimant” is often applied to
debtholders
common stockholders
the lawyer representing creditors at a bankruptcy hearing
a party that is able to purchase firm assets at cheap prices due to a hasty liquidation |
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Definition
|
|
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 systems
greater protection is afforded to shareholders and creditors, resulting in decreased tendencies towards entrepreneurship
public equity markets are larger than in countries with other legal systems but entrepreneurial tendencies are relatively low
entrepreneurship tendencies are higher due to low expected bankruptcy costs
markets 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 |
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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. |
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Term
The primary instruments used for long-term financing include all of the following except:
commercial paper
common stock
preferred stock
long term debt
all of the above |
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Definition
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Term
When M & M assume that capital markets are frictionless it means __________.
no taxes
no transaction costs
investors can borrow and lend at the same rate that corporations can
all of the above
none of the above |
|
Definition
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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 million
PV interest tax shields = Tc D
= 0.35($6.5m)
= $2.275m |
|
|
Term
Financial leverage:
Increases expect EPS and Increases EPS volatility
Increases expect EPS and Decreases EPS volatility
Decreases expect EPS and Increases EPS volatility
Decreases 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 Manufacturing
High-tech
Food Chain
Retailing |
|
Definition
|
|
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
|
|
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 __________.
WACC
required return on equity
target leverage zones
secured debt hypothesis
none 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 markets
target leverage zones
homemade leverage
arbitrage
none of the above |
|
Definition
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|
Term
Firms in the __________ industry(ies) use a great deal of debt.
Technology
Pharmaceutical
Software
Utility |
|
Definition
|
|
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 level
would show a high book-value leverage level
would contain a high long-term debt level
would contain a high total debt level
would 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 ratio
The levered firm’s equity expect return does not change with the debt-to-equity level
Rises with the debt-to-equity ratio
Rises with the debt-to-equity ratio
Proposition 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 date
Ex-dividend date; record date; payment date
Record date; ex-dividend date; payment date
Record 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; do
Should; do not
Should not; do
Should not; do not |
|
Definition
|
|
Term
The agency theory that best explains the dividend behavior or large mature firms generating substantial free cash flow:
The M&M Irrelevancy theory
The catering theory
The signaling model
The 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 policy
a low-regular-and-extra dividend policy
a high dividend payout level
a low dividend payout level
an 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 fall
firms will payout all earnings in dividends rather than retain earnings
corporate dividend payout ratios will be irrelevant
firms will retain all earnings rather than pay dividends
firms 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 split
a 1-for-2 split
a share repurchase program
a stock dividend program
the payment of an extra dividend |
|
Definition
|
|
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 date
payment date
record date
ex-dividend date
shareholders of record date |
|
Definition
|
|
Term
Paying dividends when investors assign a premium to dividend paying stocks is associated with
The dividend premium theory
The catering theory
The signaling model
The agency/contracting model |
|
Definition
|
|
Term
Which of the following best describes the empirical evidence regarding dividends?
Taxes influence dividends, firms manage dividends, and most firms do not pay dividends
Taxes influence dividends, dividends are residual, most firms pay dividends
Taxes influence dividends, firms manage dividends, most firms pay dividends
Taxes 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 |
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