FINA3000 T/F Test 2

A stock’s required return is greater than its expected return.
We say that the stock is undervalued

false

The slope of the SML is the market portfolio risk premium.

true

It is possible for a stock to have a greater stand alone risk than the market portfolio and still have a beta less than 1

true

Preferred stock is considered equity on the balance sheet

true

Beta represents the diversifiable risk of stock “i” divided by the diversifiable risk of the market portfolio

false

If two project are mutually exclusive, the IRR rule is preferred over the NPV rule

false

The market portfolio risk premium is constant for all stocks, regardless of beta

true

A firm has both preferred stock and common stock on their balance sheet. We can say that the preferred stock is less risky than the common stock

true

Two firms have similar cost structures. Firm A’s sales have greater correlation to the market than Firm B’s sales, All else equal, we would have Firm A to have a higher Beta than B

true

A short squeeze refers to the hedge fund strategy that punishes retail investors that overvalue a stock

false

Modigliani and Miller would say to finance your firm with as much debt as possible in a world with taxes and no default risk

true

In general, we should see a higher NPV for a project that uses MACRS rather than straight-line depreciation

true

Suppose that Home Depot decides to enter the commercial building. The company believes that the synergy from selling building supplies will make the move profitable. We do know that the commercial building environment is riskier than Home Depot’s current project profiles. If Home Depot decides to use their firm WACC to evaluate these new building projects, there is a chance that Home Depot will accept a project that should be rejected.

true

Since firm debt does not consistently trade, we estimate the firm cost of capital by using only CAPM

false

Our general rule of thumb for optimal cycle length is that the firm should continue a project while the yearly cash flows are positive

false

A firm had a surprising increase in Accounts Payable over the las 12 months. This increased the FCF for the firm

true

ETF stands for equity traded fund

false

In our valuation unit, a weakness of the DCF model is it does not use the cost of capital

false

The payback decision rule will rank projects in the same order as the NPV rule

false

Sensitivity analysis examines the impact on NPV if you change the value of one variable

true

Dr. pope mentioned that “long” options or call options can sometimes be part of employee compensation

true

According to our SML model, stock prices will increase if the federal reserve increases interest rates

false

If the cost of capital is equal to the IRR, the project will have an NPV of 0

true

A company decides to enter a business that is outside their normal scope of business activity and risk. The new business is riskier than the typical project considered by the firm. If the firm uses its usual cost of capital, there is a chance that the firm may reject a project that should be accepted

false

Firms favor accelerated depreciation because it leads to higher NPV’s for a capital budgeting project

true

Firms with more cyclical revenues are likely to have a higher beta than firms with non-cyclical revenues (all else equal)

true

Suppose a firm has give projects that are all mutually exclusive. Our strategy would be to calculate the NPC for each project and take all projects with a positive NPV

false

If the value of accounts payable increases over the course or the year, it will create a positive impact on he firm’s FCF

true

If the expected return on a stock is greater than its required return, we say the stock is currently overvalued

false

When a trader engages in short selling, the risk is higher because the losses to the trader are potentially unlimited

true

A corporation will create a forward contract to lock a future exchange rate. The corporation does this to remove exchange rate risk.

true

A dividend Appreciation mutual fund would likely be called an Income Fun

true

Dr Pope suggested that International Funds have more importance in your portfolio now as the US has grown more isolated from the rest of the world

false

In our Gamestop current event, a “short squeeze” describes a situation where the stock price falls due to a high percentage of short positions

false

With the security market line, our model would predict a decline in stock prices if the Federal Reserve were to raise interest rates

true

An all equity firm would have a capital structure of 100% common equity and would be considered a highly leveraged firm

false

Stock A has a stand alone risk of 50%, while the relevant risk of the market portfolio is 30%.n We can say stock A always has a higher beta than the market portfolio.

false

If we were to rank based on risk to the investor, preferred stock would be considered riskier than debt and common stock.

false

When a project has a positive NPV, this means that the extra wealth created by the project will be shared with only the common shareholder

true

The market portfolio risk premiums is constant for all stocks

true

The higher the correlation between stock “i” retrns and the returns on the market portfolio, the greater the relevant risk for stock “i”

true

The risk-free investment should have a beta equal to 1

false

If we increase the inventory for the firm, we will decrease the FCF for the current year everything else constant

true

a Company decides to enter a business that is outside their normal scope of business activity and risk. The new business is riskier than the typical project considered by the firm. If the firm uses its usual cost of capital, there is a chance that the firm may accept a project that should be rejected

true

Firms favor straight line depreciation because it leads to higher NPVs for a capital budgeting project

false

The greater a firm’s percentage of fixed costs, the greater the firm’s degree of operation leverage

true

In our personal finance lecture, Dr Pope suggested that college students might prefer mutual funds over exchange traded funds do the cheaper prices

false

The yearly free cash flow for a firm can be negative

truee

If two project are mutually exclusive, we would favor the IRR rule over the NPV rule to pick the best project

false

If we are only considering one project, the NPV and IRR rule will always agree

true

Sensitivity analysis involves changing the value of one variable and observing the impact on NPV

true

Modigliani and Miller argue that a firm’s value is independent of its capital structure in a world with no taxes and no default risk

true

When a project has a positive NPV, this means that the extra wealth created by the project will be shared with all investor types

false

With our SML graph, we would expect stock prices to increase if the Federal Reserve Bank reduced the risk free rate

true

A DRIP investment features high liquidity

false

The risk free investment should have a beta equal to 0

true

If projects are mutually exclusive, we favor the NPV rule over the IRR rule

true

The WACC only includes the required return for common shareholders

false

For capital budgeting, the NPV will be higher if you can take more depreciation earlier in the life of the project

true

For a student just graduating Terry and starting a 401k plan, Dr Pope would likely favor a mid-cap fund over an income fund

true

All else equal, a firm with cyclical revenues would have a higher beta than a firm with non cyclical revenues

truePre

Preferred stock dividends most closely resemble our TVM growing annuity formula

false

Suppose that Academy SPorts decides to open up a smoothie bar within their retail stores. This would likely create a positive side effect for the existing stores

true

If we increase leverage for a firm, the result will be increased expected return for the shareholder and increased risk

true

Using the SML, we showed that stock prices should increase when the Federal Reserve raises the risk free rate

false

Scenario analysis is useful because it gives you a full range of possible outcomes for a project’s NPV

true

For capital budgeting, a firm would prefer the MACRS depreciation method over straight line for a capital budgeting project

true

When projects are mutually exclusive, we prefer the NPV rule over the IRR rule for selecting the best project

true

Moral hazard describes the situation where banks discriminate against borrowers based on the size of their accounts

false

If you sell an asset for greater than its book value, you will receive a tax credit

false

The market portfolio risk premium will be large for a start up firm than an established firm

false

ETF stands for exchange traded fund

true

In general, we would expect an income fund to provide greater returns than an index fund

false

For the payback rule, it is generally accepted that we take any project with a payback less than 5 years

false

A firm has an increase in the balance of its accounts pauable over the past 12 months. All else equal, this will result in a decrease in the FCF for the current uear

false

Gamestop is an example of a company that accelerated its growth during COVID and was able to boost its stock price as a result

false

When a project increases the sales of other products, we say it creates synergy within the firm

true

Firms favor straight line depreciation over accelerated depreciation because it leads to higher NPVs for a capital budgeting project

false

We value a share of preferred stock using the present value of a perpetuity formula

true

Using the SML, if the Federal Reserve Bank reduces the risk free rate, we should see an increase in stock prices

true

In class, we identified one strength of the multiples model is that it uses the cost of capital.

false

The IRR rule is better to use than the NPV rule because the NPV rule can be biased based on the scale of the project

The security market line shows the required return of an investment as a function of its beta

The interest rate used in the NPV calculation for a capiatl bugeting project only represents the required return for shareholders in the firm

false

The market portfolio risk premium is smaller for larger firms than smaller firms

false

A project with a shorter payback period will always have a larger NPV than a project with a longer payback period

falseA

An analyst is trying to estimate the cost of capital for Uber. The analyst observes that Uber has existing debt on its balance sheet that pays a 4% coupon rate. The analyst decides to use 4% as the cost of debt in the WACC calculation. Is this correct reasoning?

false

FCF measure the cash created by the firm after all investments are made and after all dividends and interest is paid

false

Another name for relevant risk is diversifiable risk

false

In Modigliani and Miller’s proposition with taxes, the optimal capital structure is to use as much leverage as possible

true

The term “i-flipping” refers to the practice of short selling a stock and profiting with the price of the stock falls

false

Monte Carlo simulation can give you a usable result with one trial

false

In our personal finance lecture, Dr Pope suggested that most students would want to have an income fund as part of their 401k when starting work

false