Which of the following best describes the Net Present Value rule?
A) Take any investment opportunity where the net present value (NPV) is not
negative; turn down any opportunity when it is negative.
B) Take any investment opportunity where the net present
A) Take any investment opportunity where the net present value (NPV) is not
negative; turn down any opportunity when it is negative.
Which of the following investment decision measures is best defined as the amount of
time it takes to pay back the initial investment?
A) internal rate of return (IRR)
B) profitability index
C) net present value (NPV)
D) payback period
D) payback period
Which of the following is NOT a limitation of the payback period rule?
A) It does not account for time value of money.
B) It is difficult to calculate.
C) It ignores cash flows after payback.
D) The cut-off payback period is determined arbitrarily.
B) It is difficult to calculate.
Which of the following best defines incremental earnings?
A) cash flows arising from a particular investment decision
B) the amount by which a firm's earnings are expected to change as the result of an
investment decision
C) the earnings arising from all
B) the amount by which a firm's earnings are expected to change as the result of an
investment decision
Cameron Industries is purchasing a new chemical vapor depositor in order to make
silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered
and installed. Building a clean room in the plant for the machine will cost an addi
C) the redesign of the plant only
Which of the following costs would you consider when making a capital budgeting
decision?
A) sunk cost
B) opportunity cost
C) interest expense
D) fixed overhead cost
B) opportunity cost
Which of the following adjustments should NOT be made when computing free cash
flow from incremental earnings?
A) adding back depreciation expenses
B) subtracting capital expenditures
C) subtracting increases in Net Working Capital
D) subtracting deprecia
D) subtracting depreciation expenses
Which of the following formulas will correctly calculate Net Working Capital?
A) Cash + Inventory + Receivables + Payables
B) Cash + Inventory + Receivables - Payables
C) Cash + Inventory - Receivables + Payables
D) Cash - Inventory + Receivables + Payabl
B) Cash + Inventory + Receivables - Payables
If you want to value the equity of a firm's equity that consistently pays out its earnings
as dividends, the simplest model for you to use is the
A) enterprise value model.
B) total payout model.
C) dividend-discount model.
D) discounted free cash flow mo
C) dividend-discount model.
If you want to value the equity of a firm that has consistent earnings growth, but varies
how it pays out these earnings to shareholders between dividends and repurchases, the
simplest model for you to use is the
A) enterprise value model.
B) dividend-dis
C) total payout model.
If you want to value the equity of a firm but do not want to explicitly forecast its
dividends, share repurchases, or its use of debt, what is the simplest model for you to use?
A) the discounted free cash flow model
B) the dividend-discount model
C) the
A) the discounted free cash flow model
Which of the following statements is FALSE?
A) In a share repurchase, the firm uses excess cash to buy back its own stock.
B) The discounted free cash flow model begins by determining the value of the
firm's equity.
C) The discounted free cash flow model
B) The discounted free cash flow model begins by determining the value of the
firm's equity.
Which of the following statements is FALSE?
A) To estimate a firm's enterprise value, we compute the present value (PV) of the
free cash flows (FCF) that the firm has available to pay equity holders.
B) The net present value (NPV) of any individual projec
A) To estimate a firm's enterprise value, we compute the present value (PV) of the
free cash flows (FCF) that the firm has available to pay equity holders.
Which of the following statements is FALSE?
A) The more cash the firm uses to repurchase shares, the less it has available to pay
dividends.
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B) Free cash flow measures the cash generated by the firm after payments to debt or
equity holders are consider
B) Free cash flow measures the cash generated by the firm after payments to debt or
equity holders are considered.
Which of the following statements is FALSE?
A) The firm's weighted average cost of capital, denoted rwacc, is the cost of capital that
reflects the risk of the overall business, which is the combined risk of the firm's equity
and debt.
B) Intuitively, the
D) When using the discounted free cash flow model we should use the firm's equity
cost of capital.
Which of the following statements is FALSE?
A) The long-run growth rate of free cash flows, gFCF, is typically based on the expected
long-run growth rate of the firm's revenues.
B) Because the firm's free cash flow is equal to the sum of the free cash flo
C) If the firm has no debt, then rwacc equals the risk-free rate of return.
Which of the following models can be used to value a firm without explicitly
forecasting that firm's dividends, share repurchases, or its use of debt?
I. Dividend-discount model
II. Total payout model
III. Discounted free cash flow model
A) I only
B) II o
C) III only
The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that
this will increase her cash flow by $220,000 per year. She constructs the above graph,
which shows the net present value (NPV) as a function of the discount rate. If her
B) No, because the NPV is negative at that rate.
Which of the following situations can lead to IRR giving a different decision than NPV?
A) Delayed investment
B) Multiple IRRs
C) Differences in project scale
D) All of the above can lead to IRR giving a different decision than NPV
D) All of the above can lead to IRR giving a different decision than NPV
Which of the following best explains why is it sensible for a firm to use an accelerated
depreciation schedule such as MACRS rather than straight-line depreciation?
A) The firm will substantially decrease its depreciation tax shield across all of the
depr
D) The firm will receive greater benefits to its cash flow earlier in the depreciation
timeline and thus increase net present value (NPV).
A real option in a project refers to:
A) The option to discount cash flows at a higher rate
B) The right but not the obligation to make a certain business decision
C) The obligation to delay a project
D) The right to rescind all future cash flows
B) The right but not the obligation to make a certain business decision
Real options in projects generally:
A) Increase the value of the project to investor
B) Decrease the value of the project to the investor
C) Do not impact the value of the project
A) Increase the value of the project to investor
When different investment rules give conflicting answers, then decisions should be
based on the Net Present Value rule, as it is the most reliable and accurate decision rule.
A) True
B) False
A) True
You are opening up a brand new retail strip mall. You presently have more potential
retail outlets wanting to locate in your mall than you have space available. What is the most
appropriate tool to use if you are trying to determine the optimal allocation
D) Profitability index
Which of the following would you NOT consider when making a capital budgeting
decision?
A) The additional taxes a firm would have to pay in the next year
B) The cost of marketing study completed last year
C) The change in direct labor expense due to the p
B) The cost of marketing study completed last year
Which of the following is NOT a diversifiable risk?
A) the risk that the economy slows, reducing demand for your firm's products
B) the risk that the CEO is killed in a plane crash
C) the risk of a key employee being hired away by a competitor
D) the risk
A) the risk that the economy slows, reducing demand for your firm's products
Because investors can eliminate unsystematic risk "for free" by diversifying their
portfolios, they __________ a risk premium for bearing it.
A) won't earn
B) require
C) are indifferent about
D) none of the above
A) won't earn
The risk premium of a security is determined by its __________ risk and does not
depend on its __________ risk.
A) systematic, undiversifiable
B) systematic, unsystematic
C) diversifiable, diversifiable
D) all of the above
B) systematic, unsystematic
While __________ seems to be a reasonable measure of risk when evaluating a large
portfolio, the __________ of an individual security does not explain the size of its
average return.
A) volatility, volatility
B) the mean return, standard deviation
C) mode
A) volatility, volatility
Many former employees at Enron had a large part of their portfolio invested in Enron
stock. These employees were bearing a high degree of __________ risk.
A) unsystematic
B) systematic
C) market specific
D) non-diversifiable
A) unsystematic
A portfolio of stocks can achieve diversification benefits if the stocks that comprise
the portfolio are
A) not perfectly correlated.
B) perfectly correlated.
C) susceptible to common risks only.
D) both B and C
A) not perfectly correlated.
Companies that sell household products and food have very little relation to the state
of the economy because such basic needs do not go away. These stocks tend to have
__________ betas.
A) high
B) low
C) negative
D) cannot say for sure
B) low
Diversification reduces the risk of a portfolio because __________ and some of the
risks are averaged out of the portfolio.
A) stocks do not move identically
B) stocks have common risks
C) stocks are unpredictable
D) stocks are always effected by the mark
A) stocks do not move identically
We can reduce the volatility of stock portfolios without sacrificing expected returns by
investing in less than perfectly correlated assets through diversification because the
expected return of a portfolio is the weighted average of the expected returns
C) is less than the weighted average volatility.
The volatility of Home Depot Share prices is 30% and that of General Motors shares is
30%. When I hold both stocks in my portfolio and the stocks returns have zero correlation,
the overall volatility of returns of the portfolio is
A) unchanged at 30%.
B)
B) less than 30%.
Which of the following statements is FALSE?
A) Stock returns will tend to move together if they are affect similarly by economic
events.
B) Stocks in the same industry tend to have more highly correlated returns than stocks in
different industries.
C) Alm
C) Almost all of the correlations between stocks are negative, illustrating the general
tendency of stocks to move together.
For each 1% change in the market portfolio's excess return, the investment's excess
return is expected to change by __________ percent due to risks that it has in common
with the market.
A) beta
B) alpha
C) zero
D) cannot say for sure
A) beta
The beta of the market portfolio is:
A) 0
B) -1
C) 2
D) 1
D) 1
The S&P 500 index traditionally is a __________ portfolio of the 500 largest U.S.
stocks.
A) value weighted
B) equally weighted
C) chain weighted
D) price weighted
A) value weighted
The Capital Asset Pricing Model asserts that the __________ return is equal to the
risk-free rate plus a risk premium for systematic risk.
A) realized return
B) expected return
C) holding period return
D) ex-post return
B) expected return
The excess return is the difference between the average return on a security and the
average return for
A) Corporate bonds.
B) a portfolio of securities with similar risk.
C) a broad-based market portfolio like the S&P 500 index.
D) Treasury bills.
D) Treasury bills.
Apple's stock price jumped when it announced that its revenue had increased because
of the successful launch of iPad and the increased sales of Macbook computers. This is an
example of
A) market risk.
B) unsystematic risk.
C) systematic risk.
D) both A an
B) unsystematic risk.
As we increase the number of stocks in a portfolio, the standard deviation of returns
of the portfolio
A) increases.
B) remains unchanged.
C) decreases.
D) none of the above
C) decreases.
Because investors can eliminate unsystematic risk "for free" by diversifying their
portfolios, they ________ a risk premium for bearing it.
A) do not require
B) require
C) are indifferent about
D) none of the above
A) do not require
Many former employees at Enron, an energy trading and supply company, had a large
part of their portfolio invested in Enron stock. These employees were bearing a high degree
of ________ risk.
A) unsystematic
B) systematic
C) market specific
D) non-diversi
A) unsystematic
Which of the following is NOT a systematic risk?
A) the risk that the global price of oil rises, increasing production costs
B) the risk that the economy slows, reducing demand for your firm's products
C) the risk that your new product will not receive re
C) the risk that your new product will not receive regulatory approval
Which of the following statements is FALSE?
A) The risk premium of a security is determined by its systematic risk and does not
depend on its diversifiable risk.
B) When we combine many stocks in a large portfolio, the firm-specific risks for each
stock w
C) Fluctuations of a stock's returns that are due to firm-specific news are common
risks.
The volatility of Home Depot share prices is 30% and that of General Motors shares
is 30%. When I hold both stocks in my portfolio and the stocks returns have a correlation
of +1, the overall volatility of returns of the portfolio is
A) more than 30%.
B)
C) unchanged at 30%.
The volatility of Home Depot share prices is 30% and that of General Motors shares
is 30%. When I hold both stocks in my portfolio with an equal amount in each, and the
stocks returns have a correlation of -1, the overall volatility of returns of the port
C) zero.
Stocks tend to move together if they are affected by
A) company specific events.
B) common economic events.
C) unrelated to the economy.
D) idiosyncratic shocks.
B) common economic events
Which of the following statements is FALSE?
A) A stock's return is perfectly positively correlated with itself.
B) When the covariance equals 0, the stocks have no tendency to move either together or
in opposition of one another.
C) The closer the correla
D) The variance of a portfolio depends only on the variance of the individual stocks.
If you build a large enough portfolio, you can diversify away all ________ risk, but
you will be left with ________ risk.
A) diversifiable, unsystematic
B) unsystematic, systematic
C) systematic, undiversifiable
D) diversifiable, diversifiable
B) unsystematic, systematic
. A linear regression was done to estimate the relation between Sprint's stock returns
and the market's return. The intercept of the line was found to be 0.23 and the slope was
1.47. Which of the following statements is true regarding Sprint's stock?
A) S
B) Sprint's beta is 1.47
You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta
of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of
General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which
A) XOM, GM
An article in today's Wall Street Journal reports that Microsoft reported profits were
larger than expected. If markets follow the efficient market hypothesis:
A) The stock price will have already adjusted to incorporate this new information.
B) The stock
A) The stock price will have already adjusted to incorporate this new information.
You are playing a simple gambling game with your friend with $100 at stake. The
outcome is that you win double your bet if it is heads and lose the amount betted if it turns
out to be tails. Will a rational investor prefer 1 play with a bet for $100 or 10
B) 100 plays for $1 each.
The risk of interest rates changing in an economy is an example of:
A) Diversifiable risk
B) Systematic Risk
C) Non-diversifiable risk
D) Both B) and C)
D) Both B) and C)
The risk premium for diversifiable risk is:
A) Negative
B) Zero
C) Positive
D) None of the above
B) Zero
The volatility of returns for the stock of IBM is 35% and that for Ford is also 35% per
year. This means that they have the same:
A) Diversifiable risk
B) Systematic Risk
C) Non-diversifiable risk
D) None of the above
D) None of the above
A portfolio's Beta captures the:
A) Change in the value of a portfolio as the risk free rate changes.
B) Change in the value of a portfolio as the value of the market portfolio changes.
C) Change in the unsystematic risk of a portfolio.
D) None of the abo
B) Change in the value of a portfolio as the value of the market portfolio changes.
In general, it is possible to eliminate ________ risk by holding a large portfolio of
assets.
A) unsystematic
B) systematic
C) unsystematic and systematic
D) market
A) unsystematic
A company's stock price jumped when it announced that its revenue had decreased
because of the quality issues of its products. This is an example of ________.
A) market risk
B) unsystematic risk
C) systematic risk
D) undiversifiable risk
B) unsystematic risk
The risk premium of a stock is not affected by its ________.
A) undiversifiable risk
B) market risk
C) systematic risk
D) unsystematic risk
D) unsystematic risk
If the Federal Reserve were to change from an expansionary to a contractionary
monetary policy, this would be an example of ________.
A) unsystematic risk
B) systematic risk
C) independent risk
D) diversification risk
B) systematic risk
To attract capital from outside investors, a firm must offer potential investors an
expected return that is commensurate with the level of risk that they can bear.
A) True
B) False
A) True
The WACC does not depend on the risk of a company's line of business.
A) True
B) False
B) False
Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags
theme parks. Anheuser Busch should use the ___________ to evaluate the business of Six
Flags.
A) WACC of Anheuser Busch
B) WACC of Six Flags
C) Average market return
D) Divisio
B) WACC of Six Flags
The cash flow from a change in Net Working Capital is always equal in size and
opposite in sign to the changes in Net Working Capital.
A) True
B) False
A) True