Finance exam CH 9, 11, 14, 10

preferred stock

A special type of stock whose owners, though not generally having a say in running the company, have a claim to profits before other stockholders do.

common stock

the most basic form of ownership, including voting rights on major issues, in a company

preferred stock advantage

Preserves a company's debt capacity while raising funds like debt

preferred stock advantage

Accepted as equity

preferred stock advantage

Lower capital cost than common stock

preferred stock advantage

Provides tax benefits to some owners

preferred stock limitation

Not tax deductible

preferred stock limitation

Missed dividend could lead to a strong reaction from creditors and stockholders

common stock

Stock that has voting rights

preferred stock

stock that has an obligation to pay dividends

interest rate

Percentage of amount borrowed to be added to the amount loaned and paid back

yield to maturity

the rate of return a bondholder will receive if the bond is held to maturity

floating rate

the rate of interest moves up and down, reflecting economic or financial market conditions

net present value

The difference between the present value of an investment project's cash inflows and the present value of its cash outflows.

Dividend Growth Model

a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate

bond

a formal contract to repay borrowed money with interest at fixed intervals

scenario analysis

process of devising a list of possible economic scenarios and specifying the likelihood of each one. includes a large number of items

Sensitivity Analysis

investigation of what happens to NPV when only one variable is changed tests one variable

Simulation Analysis

Estimation of the probabilities of different possible outcomes, tests unlimited number of items

Capital Asset Pricing Model (CAPM)

a model based on the proposition that any stock's required rate of return is equal to the risk-free rate of return plus a risk premium that reflects only the risk remaining after diversification

Liquidity premium

the extra expected return demanded by investors as compensation for the greater risk of longer-term bonds

Capital Structure

the mixture of debt and equity maintained by a firm

cost of capital

the minimum rate of return or profit a company must earn before generating value, What it cost me (the firm) to sell debt to you (the investor)

cost of equity

the return that equity investors require on their investment in the firm

mutually exclusive

a statistical term describing two or more events that cannot happen simultaneously

Payback period

the amount of time required for an investment to generate cash flows sufficient to recover its initial cost

internal rate of return

a metric used in financial analysis to estimate the profitability of potential investments, the discount rate that makes the NPV of an investment zero

Weighted Average Cost of Capital (WACC)

a firm's average after-tax cost of capital from all sources, including common stock, preferred stock, bonds, and other forms of debt

callable bonds

bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity

Non-Callable Bond

Absolute protection against call prior to maturity.

Why is a callable bond riskier than a non-callable bond?

If bond is called from you, the interest rate can be lower than an original investment

Cumulative Vote

voters are given multiple votes which they can cumulate for one alternative and there are multiple seats.

straight voting

a procedure in which a shareholder may cast all votes for each member of the board of directors

voting by proxy

authorizing someone else to vote the shares owned by the shareholder

indenture

Contract between the company and the bondholders

If NPV of project is negative, how can you make it positive?

change cash flows, increase length of project or adjust interest rate

soft rationing

when units in a business are allocated a certain amount of financing for capital budgeting

hard rationing

when a business cannot raise financing for a project under any circumstances

The liquidity preference hypothesis of the term structure of interest rates argues that long-term rates must be ________ than short term rates due to _________.
A. Lower, default risk.
B. Higher, interest rate risk.
C. Lower, expected inflation

Higher, interest rate risk

An indenture is:
A. the written record of all the holders of a bond issue.
B. a bond that is secured by the inventory held by the bond's issuer.
C. the legal agreement between the bond issuer and the bondholders.

the legal agreement between the bond issuer and the bondholders

A bond that can be paid off early at the issuer's discretion is referred to as being which one of the following?
A . senior.
B. callable.
C. unsecured.

callable

With everything else held constant, the yield to maturity of a bond:
A. Will equal the coupon rate if the bond sells at face value.
B. Is constant in the financial market over the life of the bond.
C. Will increase if the risk of the bond decreases.

Will equal the coupon rate if the bond sells at face value.

You own a bond that has a 6% annual coupon and matures 5 years from now. You purchased this 10- year bond at par value when it was originally issued. Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8%?
A. The current yield-to-maturity is greater than 6%.
B. The bond is currently valued at one-half of its issue price.
C.You will realize a capital gain on the bond if you sell it today.

You will realize a capital gain on the bond if you sell it today.

With everything else held constant, an AA rated bond will have:
A. AA higher yield-to-maturity than an A rated bond
B. A lower yield to maturity than an AAA rated bond.
C. A lower yield-to-maturity than an A rated bond.

A lower yield-to-maturity than an A rated bond.

A 6%, annual coupon bond is currently selling at a premium and matures in 7 years. The bond was originally issued 3 years ago at par. Which one of the following statements is accurate in respect to this bond today?
A. The coupon rate is greater than the current yield.
B. The yield-to-maturity is less than the coupon rate.
C. The bond is worth less today than when it was issued.

The yield-to-maturity is less than the coupon rate.

Floating-rate notes are:
A. Bonds with a variable interest rate.
B. Short-term lines of credit type basis loans.
C. Bonds with maturity greater than 10 years with a fixed coupon payment.

Bonds with a variable interest rate.

The liquidity premium is compensation to investors for:
A. redeeming a bond prior to maturity
B. purchasing a bond in the secondary market.
C. the lack of an active market wherein a bond can be sold for its actual value.

the lack of an active market wherein a bond can be sold for its actual value.

The above term structure of interest rates represents the relationship between:
A. Nominal rates on bonds and time to maturity.
B. Maturity dates and real interest rates on risky bonds.
C. Nominal and real rates on default-free, pure discount bonds.

Nominal rates on bonds and time to maturity.

Evaluating the 30year yield change from 7/22/11 to 8/22/11, the change in bond yields would indicate?
A. Bond prices have declined.
B. Bond prices have increased.
C. Cannot determine a change in bond prices.

Bond prices have increased

Which of the following is a characteristic of preferred stock:
A. It has a claim of ownership on the firm.
B. It is senior to common stock in bankruptcy.
C. It has voting privileges for the firm's board of directors.

It is senior to common stock in bankruptcy.

Which one of the following is an underlying assumption of the dividend growth model?
A. A stock's value changes in direct relation to the required return
B. Stocks that pay the same annual dividend have equal market values.
C. A stock's value is equal to the discounted present value of the future cash flows from dividends paid investors.

A stock's value is equal to the discounted present value of the future cash flows from dividends paid investors.

You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called?
A. cumulative voting
B. straight voting
C. voting by proxy

voting by proxy

Which one of the following statements concerning scenario analysis is correct? Scenario analysis:
A. defines the entire range of results that could be realized from a proposed investment project.
B. determines which variable has the greatest impact on a project's final outcome.
C. helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions.

helps managers analyze various outcomes that are possible given reasonable ranges for each of the assumptions.

Which one of the following statements related to the CAPM approach to equity valuation is correct? Assume the firm uses debt in its capital structure.
A. This model considers a firm's rate of growth
B. The model applies only to non-dividend paying firms.
C. The model is dependent upon a reliable estimate of the market risk premium

The model is dependent upon a reliable estimate of the market risk premium

The pre-tax cost of debt is:
A. based on the current yield to maturity of the firm's outstanding bonds.
B. equivalent to the average current yield on all of a firm's outstanding bonds.
based on the original yield to maturity on the latest bonds issued by a firm.

based on the current yield to maturity of the firm's outstanding bonds.

What is the outcome when the cost of equity capital is combined with after-tax cost of debt?
A. cost of capital
B. target capital structure
C. weighted average cost of capital

weighted average cost of capital

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?
A. Risk level of the project
B. Mix of funds used to finance the project
C. Amount of debt used to finance the project

Risk level of the project

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:
A. automatically maximizes the total value created for its shareholders.
B. encourages the division managers to only recommend their most conservative projects.
C. automatically gives preferential treatment in the allocation of funds to its riskiest division.

automatically gives preferential treatment in the allocation of funds to its riskiest division

The cost of capital for a project depends primarily on which one of the following?
A. How the project uses its funds
B. Source of funds used for the project
C. Division within the firm that undertakes the project

How the project uses its funds

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.
A. The aftertax cost of debt just decreased.
B. The initial cash outlay requirement is reduced.
C.The manager learns the project is riskier than previously believed.

The manager learns the project is riskier than previously believed.

Which one of the following statements is correct?
A. The net present value is a measure of profits expressed in today's dollars.
B. The net present value is positive when the required return exceeds the internal rate of return.
C. If the internal rate of return equals the required return, the net present value will equal zero.

If the internal rate of return equals the required return, the net present value will equal zero.

Based on the most recent survey information presented in your textbook, CFOs tend to use which two methods of investment analysis the most frequently?
A. Payback and net present value
B. Payback and internal rate of return
C. Internal rate of return and net present value.

Internal rate of return and net present value.

Net present value:
A. is the best method of analyzing mutually exclusive projects.
B. is less useful than the internal rate of return when comparing different sized projects.
C. is less useful than the profitability index when comparing mutually exclusive projects.

is the best method of analyzing mutually exclusive projects.

A project has a net present value of zero. Which one of the following best describes this project?
A. The project requires no initial cash investment.
B. The summation of all of the project's cash flows is zero.
C. The project's cash inflows equal its cash outflows in current dollar terms.

The project's cash inflows equal its cash outflows in current dollar terms.

If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:
A. independent.
B. mutually exclusive.
C. economically scaled.

mutually exclusive.

Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project's net present value. What type of analysis is Mark conducting?
A. Sensitivity analysis
B. Erosion planning
C. Scenario analysis

Sensitivity analysis

Scenario analysis:
A. determines which variable has the greatest impact on a project's net present value.
B. helps determine the reasonable range of expectations for a project's anticipated outcome.
C. determines the absolute worst and absolute best outcome that could ever occur.

helps determine the reasonable range of expectations for a project's anticipated outcome.

Which one of the following will affect the capital structure weights used to compute a firm's weighted average cost of capital?
A. Decrease in the book value of a firm's equity
B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common stock

Increase in the market value of the firm's common stock

Which one of the following statements is correct, all else held constant?
A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.
C. The after-tax cost of debt increases when the market price of a bond increases.

A decrease in a firm's WACC will increase the attractiveness of the firm's investment options.