finance final

expected return

the return on a risky asset expected in the future

risk premium

expected return - risk free rate

profile beta

the weighted average of the betas of the investments included in the portfolio

risk free assets have a beta of

0

market portfolio has a beta of

1

security market line

positively sloped straight line that displays the relationship between expected return and beta

CAPM shows that the expected return for a particular asset depends on all except

the return on a risk less asset

stocks are more volatile than bonds but

have historically achieved higher average returns

benefit from diversification

the returns on different assets have less than perfect correlation

stocks will earn a certain amount next year

expected return

when calculating the expected rate of return on a stock portfolio using a weighted average, the weights are based on

the market value of the investment in each stock

unexpected returns can be either positive or negative in the short term but end to be

zero in the long term

unsystematic risk can be effectively eliminated by

portfolio diversification

spreading an investment across many diverse assets will eliminate some of the

total risk

the systematic risk of a portfolio can be lowered by adding

t bills to the portfolio

an investor who owns a well diversified portfolio would consider unsystematic risk to be

irrelevant

Nondiversifiable risk is measured by

beta

standard deviation measures

total risk

beta measures

systematic risk

the market risk premium is the slope of the

security market line

if market is efficient and securities are priced fairly, all securities will have the same

reward to risk ratio

cost of capital

minimum rate of return the firm will accept on a new project

tells you what you earned in a typical year

arithmetic average

tells you what you actually earned per year on average

geometric average

2002-2022 treasury bills had a return between

0-5%

highest average annual return 1926-2022

small company stocks

lowest average risk premium 1926-2022

US treasury bills

rate of return normally used as risk free rate of return

treasury bills

difference between two rates of return

risk premium

actual real rate of return 1926-2022

9%

probability small company stocks produce annual return that is more than one standard deviation below the average

16%

wide frequency distribution

high standard deviation, large risk premium

bonds are safer, less risky investment than

stocks

all stock prices fairly reflect all the available info on those stocks

efficient capital market

all securities in an efficient market are zero net present value investments

efficient market hypothesis

efficient financial markets fluctuate continuously because

the markets are continually reacting to new info

inside info has the least value when financial markets are

strong form efficient

studying public info to identify mispriced stocks is

ineffective

greatest profit potential to an unusually skillful professional stock analyst

weak

the percent of investment that the project costs can be referred to as all of the following except

free cash flow

cost of capital depends on use of ___ not the source

funds

a firms target capital structure represents

a fixed debt equity ratio that the company attempts to maintain

the coupon rate on firms outstanding debt is not a substitute for

the cost of debt

preferred stock is essentially a

perpetuity

the required return of preferred stock is equal to the dividend yield on the

preferred stock

using a WACC that is based on companies in similar lines of businesses

pure play approach

using a WACC that involves making subjective adjustments based upon the project

subjective approach

primary determinant of a firms cost of capital

use of funds raised

companys overall cost of equity is directly related to the

risk level of the firm

depends on how the funds raised for project are going to be spent

cost of capital

increase in firms cost of equity

decrease in risk free rate

dependent upon a reliable estimate of the market risk premium

firms estimated cost of equity

based on current yield to maturity of the companys outstanding bonds

pretax cost of debt

return investors require on the total assets of the firm

weighted average cost of capital

the projects cash inflows equal its cash outflows in current dollar terms

a project has a net present value of zero

decrease NPV of a project

increase the projects initial cost at Time 0

what method predicts the amount by which the market value of a firm will change if a project is accepted?

NPV

if a project has a NPV equal to zero, then:

the project earns a return exactly equal to the discount rate

the best method of analyzing mutually exclusive projects

NPV

computing the value of a project based on the PV of the projects anticipated cash flows

discounted cash flow valuation

the length of time a firm must wait to recoup the money it has invested in a project

payback period

the length of time a firm must wait to recoup, in PV terms, the money it has invested in a project

discounted payback period

a projects average net income divided by its average book value

projects average accounting return

the IRR is equal to the required rate of return when the

NPV is equal to zero

condensing the firms cash inflows into fewer years without lowering the total dollar amount of those inflows

increase projects IRR

the IRR that causes the NPV of the differences between two projects cash flows to equal zero

crossover rate

a project with financing type cash flows is typified by

a cash inflow at time 0

discount rate that causes the NPV of a project to equal zero

IRR

a graph that plots the NPVs of a project against the various discount rates that could be applied to the projects cash flows

NPV profile

the PV of an investments future cash flows divided by the initial cost of the investment

profitability index

a combination of cash outflows and inflows

nonconventional cash flows

rates of return are commonly used when

positive project are being considered

easy way to provide info about a proposal

internal rate of return

a high IRR can be assumed to be a

positive project to consider

the IRR does not need a

discount rate

taking one project means that we cannot take the other

mutually exclusive

when choosing between mutually exclusive projects

the highest NPV is always the best option

for low discount rates, which choice creates more value for firm?

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