Finance Exam 3

Which of the following is NOT true about capital budgeting?

It allows a firm to reverse the decision of a large capital investments at any time

Pt.1-Sykes, Inc. management is considering two projects: a plant expansion and a new computer system for the firm's production department. Classify these projects as independent, mutually exclusive, or contingent projects and explain your reasoning.

Plant expansion: independent
New computer system: independent

Pt. 2-A company is building a new plant on the outskirts of Smallesville. The town has offered to donate the land, and as part of the agreement, the company will have to build an access road from the main highway to the plant. How will the project of building the road be classified in the capital budgeting analysis?

The project of building the road be classified in the capital budgeting analysis as contingent project

Pt. 3- Management of your firm is currently considering the upgrading of the operating systems of all the firm's computers. One alternative is to choose the Linux operating system that a local computer servicesfirm has offered to install and maintain. Microsoft has also put in a bid to install the new windows operating system for businesses. How would these projects be classified?

It is a mutually exclusive project

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

Replacing production equipment

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

Cost of capital

Which of the following statements about IRR is false?

The IRR is the discount rate that makes the NPV greater than zero

Which of the following capital budgeting technique ignores the time value of money?

Payback period

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

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

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

Accounting rate of return

The cost of capital is:

All of the above (the required rate of return for new projects that have risk that is similar to that of the overall firm, the rate of return of a firm earns on its investments to satisfy the required rate of return for the firms investors, the opportunity cost of using funds on projects)

For firms that issues several types of debt, the correct cost to use when estimating its WACC is

the weighted average after-tax cost of all the debt types

It is not necessary to include the cost of lines of credit in the computation for the cost of debt because these lines tend to be temporary such that banks usually require the balances to be periodically paid down to $0, much like individuals' use of credit card debt.

True

Financial analyst use book values of each capital component when estimating their weights for use in the WACC calculation

False

The correlation between the return of two assets?

All of the above (is calculated by dividing the covariance of returns by the product of the standard deviations of the returns for the two assets
• will always have a value between –1.0 and +1.0
• measures the relative relationship between the returns of pair of assets)

A portfolio with a level of systematic risk that is the same as that of the market
has a beta that is:

equal to one

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

Underpriced

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

false

Given the historical info.in the chapter, which of the following investment classes had the highest average return?

Small U.S stocks

The two components of total risk associated with an investment are:

systematic risk and diversifiable risk

A portfolio with a level of systematic risk that is the same as that of the market has a beta that is:

equal to one

The capital asset pricing model (CAMP) measures:

the expected rate of return of an asset