Finance chap 9, 12, 13 – Flashcards
Unlock all answers in this set
Unlock answersquestion
The company cost of capital is the appropriate discount rate for a firm's
answer
average-risk projects
question
Cost of capital is the same as cost of equity for firms
answer
financed entirely by equity
question
The cost of capital for a project depends on:
answer
The use to which the capital is put, i.e. the project
question
Using the company cost of capital to evaluate a project is:
answer
Correct for projects that are about as risky as the average of the firms other assets
question
If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely?
answer
I) Rejecting good low risk projects II) Accepting poor high risk projects III) Correctly accept projects with average risk
question
If firms use the company cost of capital for evaluating all of their projects, which of the following is likely?
answer
Correctly accept projects with average risk
question
Which of the following types of projects have the highest risk?
answer
Speculation ventures
question
A firm might categorize its projects into:
answer
I) Cost improvement projects II) Expansion projects (existing business) III) New products projects IV) Speculative ventures
question
Which of the following type of projects has the lowest risk?
answer
Cost improvement
question
Which of the following type of projects has average risk?
answer
Expansion of existing business
question
The hurdle rate for capital budgeting decisions is:
answer
The cost of capital
question
The company cost of capital when debt as well as equity is used for financing is
answer
the weighted average cost of capital (WACC)
question
The after-tax weighted average cost of capital (WACC) is calculated using the formula
answer
WACC = (rD) (1 - TC ) (D/V) + (rE) (E/V) where: V = D + E
question
Cost of equity can be estimated using:
answer
A. Discounted cash flow (DCF) approach B. Capital Asset Pricing Model (CAPM) C. Arbitrage Pricing theory (APT D. The Fama-French three-factor model
question
The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15%and that of the market portfolio is 10%, 10% and 16%. According to the security market line (SML), the Stock A is:
answer
Over priced
question
On a graph with common stock returns on the Y- axis and market returns on the X-axis, the slope of the regression line represents the
answer
Beta
question
Generally, the value to use for the risk-free interest rate is:
answer
Short-term Treasury bill rate
question
Financial slang referring to the reduction of the cash flow from its forecasted value to its certainty equivalent is a
answer
Haircut for risk
question
An example of diversifiable risk that should be ignored when analyzing project risk would include
answer
Stock price fluctuations
question
A fudge factor might include
answer
Risk of government non-approval
question
What does a low standard error mean relative to beta?
answer
Beta is a reliable measurement of risk
question
In the principal-agent framework, the ultimate principal is:
answer
Shareholders
question
The following are agency problems in capital budgeting except
answer
Accepting all the positive NPV projects
question
The following are agency problems associated with capital budgeting:
answer
A. Reduced effort C. Empire building D. Perks
question
The following capital expenditure(s) are (is) included in the capital budget
answer
Investment in a new office building
question
Which of the following capital expenditure may not appear in capital budget?
answer
Investment in training employees
question
The following actions by the managers may result in over-investment problem
answer
I) entrenching investments II) empire building III) investing beyond the point where NPV falls zero
question
Managers on a fixed salary are subjected to following temptations all the time
answer
I) reduced effort II) perks or private benefits III) empire building IV) entrenching investments V) avoiding risks
question
Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers
answer
I) reduced effort II) perks or private benefits III) empire building IV) entrenching iinvestments V) avoiding risks
question
Monitoring is done by:
answer
I) Shareholders II) Board of Directors III) Independent accountants IV) Lenders
question
The ultimate responsibility for monitoring a firm rests with
answer
Shareholders
question
In large public companies monitoring is delegated to
answer
Shareholders
question
Agency costs can be reduced by monitoring
answer
I) managers efforts II) managers actions III) by intervening when managers veer off course
question
Free-rider problem in the case of monitoring results in
answer
I) ineffective monitoring by the shareholders II) monitoring being delegated III) no monitoring by a large number of small individual investors
question
Because monitoring is not perfect, managers compensation plans must be designed provide them incentives to
answer
maximize the value of the firm to the shareholders
question
Generally, mangers compensation is based on
answer
verifiable results
question
CEO compensation is the highest in
answer
USA
question
When stock options are given to managers as incentives, typically the exercise price of these options is set equal to the firms
answer
stock price on the day the options are granted.
question
The term Economic Value Added (EVA) is copyrighted by:
answer
Stern-Stewart
question
Economic Value Added (EVA) is calculated as follows
answer
EVA = Income Earned - (cost of capital) * (investment)
question
Economic profit (EP) is calculated as follows
answer
EP = (ROI - r) * (capital invested) where r = cost of capital
question
The following are disadvantages of using EVA as a measure of performance except
answer
EVA reduces explicit monitoring by top management
question
The following are advantages of using EVA as a measure of performance except
answer
EVA does not measure present value
question
EVA is used for
answer
I) Measuring performance within the firm II) Rewarding performance within the firm III) Improving performance within the firm
question
The following firms have positive EVAs
answer
A. Microsoft C. Wal-Mart Stores D. Intel Corp.
question
The following firms have negative EVAs
answer
A. Time Warner B. Pfizer C. IBM
question
The plant manager can improve EVA by
answer
I) increasing earnings IV) reducing capital employed
question
Generally, firms with high levels of intangible assets tend to report
answer
Higher than actual ROI
question
Economic rate of return is defined as:
answer
[(C1 + PV1 - PV0 )]/(PV0)
question
According to the survey of senior managers by Graham, Harvey and Rajgopal, the senior managers admitted to the following
answer
I) adjusting their firms operations and investments in order to manage earnings. II) they were willing to decrease discretionary spending in R&D, advertising or maintenance if necessary to meet earnings target. III) many of them would, if necessary, also defer or reject investment projects with positive NPVs
question
If the capital markets are efficient, then the sale or purchase of any security at the prevailing market price is
answer
Generally a zero NPV transaction
question
Financing decisions differ from investment decisions for which of the following reasons?
answer
The market for financial assets is more active
question
Financing decisions differ from investment decisions because:
answer
I) it is easy to reverse a financing decision II) the market for financial assets is very competitive III) generally, financing decisions have zero NPV
question
Generally, a firm is able to find positive NPV opportunities with
answer
Capital investment decisions
question
The statement that stock prices follow a random walk implies that:
answer
Successive price changes are independent of each other
question
The statement that stock prices follow a random walk implies that:
answer
The correlation coefficient between successive price changes (auto correlation) is not significantly different from zero.
question
Stock price cycles or patterns self-destruct as soon as investors recognize them through
answer
trading by the investors
question
Which of the following is a statement of weak form efficiency?
answer
If markets are efficient in the weak form, then it is impossible to make consistently superior profits by using trading rules based on past returns
question
Different forms of market efficiency are:
answer
I) Weak form II) Semi-strong form III) Strong form
question
Which of the following statement(s) is/are true if the efficient market hypothesis holds
answer
it implies that prices reflect all available information
question
Strong form market efficiency states that the market incorporates all information in the stock price. Strong form efficiency implies that
answer
An insider or corporate officer can not outperform the market by trading on the inside information
question
If the weak form of market efficiency holds then
answer
I) Technical analysis is useless II) Stock prices reflect information contained in past prices III) Stock price changes follow a random walk
question
Which of the following is a statement of semi-strong form efficiency??
answer
If the markets are efficient in the semi-strong form then prices will adjust immediately to public information
question
If the efficient market hypothesis holds, investors should expect
answer
I) to receive a fair price for their security II) to earn a normal rate of return on their investments
question
Predictable cycles in stock price movements
answer
self destruct as soon as investors recognize them
question
Informational efficiency in financial markets result in stock prices being
answer
fairer
question
Weak form efficiency implies that past stock price(s)
answer
do not matter
question
If the markets are efficient, none of the following investors should have above normal return on assets over time
answer
A. Those who choose their stocks by throwing darts at a list of stocks found in the financial pages of a newspaper. B. Analysts who spend considerable time evaluating the best stocks to buy. C. Mutual fund managers who manage other peoples money for a living
question
One important implication of the efficient markets hypothesis is that
answer
investors should hold a diversified portfolio and avoid active trading.
question
The semi-strong form of efficiency deals with the following type of information
answer
publiicly available information
question
The semi-strong form of has been tested by measuring how rapidly security prices react various news items like
answer
I) earnings announcements II) dividend announcements III) news of takeovers IV) macroeconomic information
question
Adjusted stock return is calculated as
answer
return on stock-return on market
question
In order to test the efficient-market hypothesis in the weak form, researchers have used the following methods except:
answer
Measurement of how rapidly security prices adjust to different news items
question
Abnormal stock return is calculated as:
answer
actual stock return-expected stock return
question
n order to test the efficient-market hypothesis in the semi-strong form, researchers have used(the):
answer
Measurement of how rapidly security prices adjust to different news items
question
The event study methodology is used in the test of:
answer
semi-strong form efficiency
question
In order to test the strong form of market efficiency, researchers have
answer
I) examined the recommendations of professional security analysts II) performance of mutual funds III) performance of pension funds
question
Which of the following observations would provide evidence against the strong form of efficient market theory
answer
Managers who trade in their own firms stocks make superior returns
question
A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can beat the market by short selling the stock of the firm that will be sued. This finding is in violation of the:
answer
Strong form market efficiency
question
Strong-form efficiency implies that mutual fund managers:
answer
Buy the index that maximizes diversification and minimizes cost of managing portfolios
question
The following are anomalies associated with market efficiency except:
answer
trading rules based on patterns
question
The various lessons of market efficiency are
answer
I) Markets have no memory II) Trust market prices III) Read the entrails IV) There are no financial illusions V) The do-it yourself alternative VI) Seen one stock, seen them all
question
Studies on behavioral finance have been developed using
answer
psychological evidence
question
Investors are particularly averse to the possibility of even a very small loss and need a high return to compensate for it. Such a concept is related to what theory
answer
Prospect theory
question
Which theory offers an explanation for the crash of a stock market one day and its rebound the next
answer
Random walk theory
