FINA 3770 Exam 3 Terms

Which of the following is true of risk and risk expected returns?

• The expected return on an investment is independent of the associated risk

• If two investments have the same expected return, investors prefer the riskier alternative.

• Higher the risk, higher the expected returns on an investment.

• The expected return on an investment is inversely proportional to the associated risk.

Which of the following is true of risk and risk expected returns?

• The expected return on an investment is independent of the associated risk

• If two investments have the same expected return, investors prefer the riskier alternative.

• Higher the risk, higher the expected returns on an investment.

• The expected return on an investment is inversely proportional to the associated risk.

Higher the risk, higher the expected returns on an investment.

To calculate expected return, each scenario is weighted by ____. 

• The overall riskiness of the investment

• The purchase price of the investment

• The probability of its occurrence

• The period in which its received 

The probability of its occurrence

If expected return on asset is greater than its required return given on Security Market Line, the stock is___

• Randomly priced

• Overpriced

• Underpriced

• Fairly priced

Underpriced

Which of the following investors should be willing to pay the highest price for an asset?

• An investor with a single-asset portfolio

• An investor with a diversified portfolio

• An investor who is not completely diversified

An investor with a diversified portfolio

Total holding period return is the dollar gain (or loss) from purchasing an asset and selling it later T/F

False, The total holding period return is the sum of the capital appreciation and income components of return

The systemic risk of an investment is measured by____

• its variance of its returns

• its beta

• the standard deviation of its returns

• the covariance of its returns

its beta

Which of the following statements is correct?

• If two investments have the same expected return, investors prefer the riskiest alternative.

• When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

• When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return.

• The greater the risk associated with an investment, the lower the return investors expe

When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

_____decisions are the most important investment decisions made by management

Capital Budgeting

To accept a capital project when using NPV,

• The project NPV should be greater than zero

• The project NPV should be less than zero

• Both the project NPV should be greater than zero and the project NPV should be less than zero

• None of these

The project NPV should be greater than zero

Which of the following is a disadvantage of the payback method?

• It is inconsistent with the goal of maximizing shareholder wealth

• It ignores the time value of money

• It ignores cash flows beyond the payback period

• All of these

All of these

Which of the following cash flow patterns is NOT an unconventional cash flow pattern?

• A cash flow pattern in which there are alternate inflows and outflows.

• A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow.

• A negative initial cash flow is followed by positive future cash flows.

• A positive initial cash flow is followed by negative future cash flows.

A negative initial cash flow is followed by positive future cash flows.

Which of the following is a key disadvantage of the IRR method?

• The IRR method is not based on a discounted cash flow technique.

• With conventional cash flows, the IRR method can yield multiple

  answers.

• With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.

• The IRR method ignores all cash flows after the arbitrary cutoff period.

With mutually exclusive projects, the IRR method can lead to incorrect investment decisions.

Which of the following is one of the steps necessary for conducting a capital budgeting analysis of a project?

• Estimating the project's future cash flows

• Deciding on how the capital required will be raised

• Determining the systematic risk of the project

• Computing the debt-to-equity ratio of the firm

Estimating the project's future cash flows

Of the four capital budgeting techniques, the one that managers use the least is:

• IRR

• Accounting Rate of Return

• Payback Period

• Net present value

Accounting Rate of Return, as ARR is based on accounting numbers and ignores the time value of money as well gives numbers based on average figures from income and balance sheet

Contingent projects would imply that…

• the acceptance of one project is dependent on the acceptance of the other.

• the projects can be either mandatory or optional.

• both the acceptance of one project is dependent on the acceptance of the other and the projects can be either mandatory or optional.

• None of these

Both the acceptance of one project is dependent on the acceptance of the other and the projects can be either mandatory or optional.

The cost of capital is…

• The return the firms had earned on a previous project

• The maximum return a project can earn

• The minimum return that a capital project must earn to be accepted

• None of these

The minimum return that a capital project must earn to be accepted

The NPV and IRR methods will always agree when you are evaluating____ projects and the projects cash flows are____

• Mutually exclusive; unconventional

• Mutually exclusive; conventional

• Independent; unconventional

• Independent; conventional

Independent; conventional

If a firm can undertake only some of the value-adding projects available to it because of limited funds, the firm must engage in…

• Capital rationing

• Capital expenditures

• Capital expansion

• Capital asset pricing

Capital rationing

Two proiects are considered to be mutually exclusive if

• selecting one would automatically eliminate accepting the other.

• the projects perform the same function.

• both selecting one would automatically eliminate accepting the other and the projects perform the same function.

• none of these.

both selecting one would automatically eliminate accepting the other and the projects perform the same function.

The internal rate of return is…

• the discount rate that makes the NPV equal to zero.

• the discount rate that makes the NPV greater than zero.

• the discount rate that makes the NPV less than zero.

• both the discount rate that makes the NPV greater than zero and the discount rate that makes the NPV less than zero.

the discount rate that makes the NPV equal to zero.

When evaluating capital projects, the decisions using the NP method and the IRR method will agree if

• The projects are mutually exclusive

• the cash flow pattern is conventional.

• both the projects are independent and the cash flow pattern is conventional.

• the projects are independent.

both the projects are independent and the cash flow pattern is conventional.

The systematic risk of an investment is measured by ____.

• Its variance of its returns

• its beta

• the standard deviation of its returns

• the covariance of its returns

Its beta

Which of the following statements is correct?

• If two investments have the same expected return, investors prefer the riskiest alternative.

• When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return.

• The greater the risk associated with an investment, the lower the return investors expect from it.

When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

Which of the following is true risk and expected returns?

• The expected return on an investment is independent of the associated risk.

• If two investments have the same expected return, investors prefer the riskier alternative.

• Higher the risk, higher the expected returns on an investment.

• The expected return on an investment is inversely proportional to the associated risk.

Higher the risk, higher the expected returns on an investment.

To calculate an expected return, each scenario is weighted by___.

• The overall riskiness of the investment

• The purchase price of the investment

• The probability of its occurrence

• The period in which it is received

The probability of its occurrence

If the expected return on an asset is greater than its required return given on the Security Market Line, the stock is____

• Randomly priced

• Overpriced

• Underpriced

• Fairly priced

Underpriced

Which of the following investors should be willing to pay the highest price for an asset?

• An investor with a single-asset portfolio.

• An investor who is so risk-averse that he does not recognize the benefits of diversification.

• An investor with a diversified portfolio.

• An investor who is not completely diversified.

An investor with a diversified portfolio.

Total holding period return is the dollar gain (or loss) from purchasing an asset and selling it later T/F

False

Which of the following statements is NOT true?

• Accepting a positive NPV project increases shareholder wealth

• Accepting a negative NPV project has no impact on shareholder wealth

• Accepting a negative NPV project decreases shareholder wealth

• Managers are indifferent about accepting or rejecting a zero NPV project

Accepting a negative NPV project has no impact on shareholder wealth

Capitol rationing implies that ___

• Funding needs are equal to funding resources

• The available capital will be allocated equally to all available projects

• A firm has constraints to fund all of the available projects

• None of these

A firm has constraints to fund all of the available projects

Which of the following represents an example of key reasons for making capital expenditures?

• Changing the capital structure of a firm

• Replacing a key executive of a firm

• Replacing a production equipment

• Floating a corporate bond isssue

Replacing a production equipment

Given the historical information in the chapter, which of the following investment classes had the highest variability returns?

• Intermediate Term Government

• Small US Stocks

• Long Term Government Bonds

• Large US Stocks

Small US Stocks

Which of the following represents a plot of the relation between expected return and systemic risk?

• The covariance of returns line

• The security market line

• The variance

• The beta coefficient

The security market line

In more recent rears more practitioners surveyed acknowledge they frequently use the NPV technique T/F

True, many managers also use multiple capital budgeting tools

One should invest in projects starting with the projects with the lowest (profitability index) Pl and then work your way up the list to that of the highest profitability until the total investment level is attained. T/F

False, one should invest with projects with the highest PI and then work your way down the list

Unlike the regular payback method, the discounted payback method does not ignore cash flows beyond a firm’s threshold period T/F

False, Discounted Payback Period does ignore all cash flows after the arbitrary cutoff period, which is a major flaw.

Unconventional cash flow patterns could lead to conflicting NPV and IRR decisions

Which of the following rates should be used to calculate a project’s net present value?

• cost of capital

• Treasury bill rate

• Required rate of return on equity

• Coupon interest rate on bonds

cost of capital

The larger the variance, the smaller the standard deviation T/F

False, standard deviation is the square root of the variance. So the larger the variance, the larger the standard deviation is.

The investments with the highest expected return have the lowest risk T/F

False, the greater risk associated with an invetsment, the greater the return investors expect from it

The net present value…

• uses the discounted cash flow valuation technique

• will provide a direct measure of how much a firm's value will change because of the capital project.

• is consistent with the shareholder wealth maximization goal.

• All of these.

All of these.

Which of the following is a characteristic of independent projects?

• Selecting one would automatically eliminate accepting the other.

• The cash flows are unrelated.

• The cash flows are related

• None of these.

The cash flows are unrelated.

One of the main reasons why the discounted payback period is not widely used by managers is that:

• It ignores the time value of money

• It ignores all cash flows that occur after the arbitrary cutoff

• It cannot be applied to long-term projects

• None of the above

It ignores all cash flows that occur after the arbitrary cutoff

The total holding period return on an investment ____

• is the difference between its selling price and its income component.

• is the difference between the selling price and the purchase price.

• consists of a capital appreciation component and an income component.

• stays constant every year.

Consists of a capital appreciation component and an income component.

A construction firm is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project to build a parking garage on a piece of land that the firm owns adjacent to the airport.

The firm's decision will be to

• accept both projects because they are independent projects.

• accept both projects because they are contingent projects.

• pick neither project.

• pick the one that adds the most value because they are mutually exclusive projects

Accept both projects because they are independent projects.