chapter 3 conceptual

Question 1

T/F: in general, if an action increases a firm’s value by providing benefits with a value greater than any costs involved, then that action is good for the firm’s investors

Answer 1

true

Question 2

T/F: to enable costs and benefits to be compared, they are typically converted into cash value at the time the benefit is received

Answer 2

false

Question 3

T/F: costs and benefits must be put in common terms if they are to be compared

Answer 3

true

Question 4

T/F: whenever a good trades in a competitive market, the price determines the value of the good

Answer 4

true

Question 5

which of the following is the overarching principle that a financial manager should follow when making decisions?

Answer 5

decisions should increase the value of the firm to its investors

Question 6

what is a competitive market?

Answer 6

a market in which a good can be bought and sold at the same price

Question 7

a U.S.-based manufacturer of sunscreen is contemplating using funds to purchase court side advertising at major tennis matches such as the French Open and the Australian Open. advertising at such well viewed international events will then raise domestic sales of the manufacturers products. which of the following factors is the most relevant when analyzing this decision?

Answer 7

the cost of the court side advertising at the tennis matches

Question 8

a firm that provides tax services to the public intends to offer a premium tax-return service at a higher price than their current services. the managers of the company ask experts in marketing to determine how much an effective ad campaign for such a service would cost, and by how much sales would increase. they consult experts in economics to calculate the increases in revenue from the success of the campaign, experts in operations to determine the cost of offering the service, and experts in strategy to anticipate possible counter-moves by competitors. which of the following points about the role of financial managers does this example illustrate?

Answer 8

real-world decisions are complex and require information from many sources if the decisions are to be valid

Question 9

why is the personal decision a financial manager makes as to whether to buy or to rent an apartment as a personal residence most like the professional decision that manager makes as to whether her firm should try to acquire a stake in a fast growing new internet-based company?

Answer 9

both decisions should be made based upon the tradeoff benefits and costs across time

Question 10

which of the following statements regarding the cost-benefit analysis is NOT correct?

Answer 10

in the absence of competitive market, we can use one-sided prices to determine exact cash values

Question 11

steve is offered an investment where for every $1 invested today, he will receive $1.10 at the end of each of the next five years. steve concludes that in five years he will have $1.10 for every $1 invested and that this investment will increase his personal value.what is steve’s major error in reasoning when making this decision?

Answer 11

he ignores the fact that the costs and benefits of the investment are not stated in the same terms

Question 12

whenever a good trades in a competitive market, the ___ determines the value of the good

Answer 12

price

Question 13

T/F: the law of one price states that if equivalent goods or securities are traded simultaneously in different competitive markets, they will trade for the same price in each market

Answer 13

true

Question 14

T/F: if an arbitrage opportunity exists, an investor can act quickly in the hope of making a risk-free profit

Answer 14

true

Question 15

which of the following best explains why market prices are useful to a financial manager when performing a cost-benefit analysis?

Answer 15

they can be used to convert different services and commodities into equivalent cash values which can be compared

Question 16

a coin collector treasures his 1969-S doubled die obverse Lincoln cent because he found it in his pocket change, rather than purchasing it. he can sell it on the open market for $35,000, but would only sell it for at least twice that price, due to sentimental value to him. it is anticipated that the coin will increase in market value in the foreseeable future. what is the value of the coin?

Answer 16

$35,000, since this is the price that the coin would fetch on the open market

Question 17

which of the following best describes the valuation principle?

Answer 17

the value of a commodity or an asset to a firm or its investors is determined by its competitive market price. when the value of the benefits exceeds the value of the costs in terms of market prices, the decision will increase the market value of the firm

Question 18

which of the following best explains why you cannot use the price of rolled oats at a local supermarket as the competitive market value of rolled oats?

Answer 18

you can buy the oats at the price posted by the store, but the store will not buy oats from you at the same price

Question 19

like other metals, uranium 308 is traded in competitive markets like the New York metals exchange. which of the following would value a given weight of uranium 308 the most?

Answer 19

all buyers and sellers would have the same value for 250 pounds of uranium 308

Question 20

which of the following statements regarding the law of one price is INCORRECT?

Answer 20

an important property of the law of one price is that it holds even in markets where arbitrage is possible

Question 21

which of the following is an example of arbitrage?

Answer 21

an investor, seeing that the price of palladium on the metals exchange in two different countries is slightly different, buys on one and sells on the other to make a profit

Question 22

why are arbitrage opportunities short-lived?

Answer 22

once investors take advantage of the opportunity, prices will respond so that the buying and selling price become equal

Question 23

the state bank offers an interest rate of 5.5% on savings and 6% on loans, while the colonial bank offers 6.5% on savings and 7% on loans. which of the following is the LEAST likely outcome of such a situation?

Answer 23

the colonial bank would experience a surge in demand for loans

Question 24

“if equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in both markets.” what do we call the above statement?

Answer 24

the law of one price

Question 25

which of the following statements regarding arbitrage and security prices is INCORRECT?

Answer 25

when a bond is underpriced, the arbitrage strategy involves selling the bond and investing some of the proceeds

Question 26

you see on Craigslist that a used XBOX 360 sells for $100 and a new XBOX 360 sells for $300. is this an arbitrage opportunity?

Answer 26

no, because the market for a used XBOX 360 is not the same as the market for a new XBOX 360

Question 27

T/F: dollar amounts received at different points in time cannot be compared in absolute terms

Answer 27

true

Question 28

T/F: the one-year discount factor is the discount at which we can purchase money in the future, one year from now

Answer 28

true

Question 29

T/F: in order to distinguish between inflows and outflows, different colors are assigned to each of these cash flows when constructing a timeline

Answer 29

false

Question 30

why should you approach every problem by drawing a timeline?

Answer 30

a timeline identifies events in a transaction or investment which might otherwise be easily overlooked

Question 31

which of the following statements is INCORRECT based on the time value of money?

Answer 31

we refer to (1-rf) as the interest rate factor for risk-free cash flows

Question 32

why is it usually necessary to use the time value of money when performing a cost-benefit analysis?

Answer 32

in most investment projects, costs are incurred up front, but benefits are received in the future

Question 33

an investor has the opportunity to buy a $10,000 government bond which is guaranteed to yield 6.5% interest in one year’s time. the investor decides to make the investment as there is a net difference between the absolute cost and benefit. which of the following is NOT a reason that the investor’s decision may be flawed?

Answer 33

it does not consider whether the $10,000 will be needed elsewhere

Question 34

how can we convert the value of money from one point in time to another?

Answer 34

using the current interest rate

Question 35

owen expects to receive $30,000 at the end of next year from a trust fund. if a bank loans money at an interest rate of 8.2%, how much money can he borrow from the bank on the basis of this information?

Answer 35

$27,726

Question 36

you are scheduled to receive $10,000 in one year. what will be the effect of an increase in the interest rate on the present value of this cash flow?

Answer 36

it will cause the present value to fall

Question 37

you are schedule to receive $10,000 in one year. what will be the effect of an increase in the interest rate on the future vale of this cash flow?

Answer 37

it will have no effect on the future value

Question 38

T/F: a dollar today and a dollar in one year may be considered to be equivalent

Answer 38

false

Question 39

T/F: the rule of 72 tells you approximately how long it takes for money invested at a given rate of compound interest to double in value

Answer 39

true

Question 40

T/F: to calculate a cash flows’ present value, you must compound it

Answer 40

false

Question 41

which of the following statements is FALSE about valuing cash at different points in time?

Answer 41

a dollar in the future is worth more than a dollar today

Question 42

which of the following statements is FALSE about valuing cash at different points in time?

Answer 42

finding the present value and compounding are the same

Question 43

to compute the future value of a cash flow, you must ?

Answer 43

compound it