Finance Final Flashcards
The capital structure weights used in computing the weighted average cost of capital:
A. remain constant over time unless the firm issues new securities.
B. are based on the market value of the firm’s debt and equity securities.
C. are computed using the book value of the long-term debt and the book value of equity.
D. are restricted to the firm’s debt and common stock.
E. are based on the book values of total debt and total equity.
are based on the market value of the firm’s debt and equity securities.
Most loans are a form of a(n)
Annuity
Decreasing the required rate of return will ________ the net present value of a project.
A. increase
B. Decrease
Increase
A decision to issue additional shares of stock is what kind of decision?
Capital structure decision
For a given time period, the higher the interest rate, the smaller the _________
present value
For a given interest rate, the higher the ______, the lower the present value
future value
What is a bond call option?
it gives the company the right to call or purchase the bonds at a specified price from bondholders
What is the yield-to-maturity of a bond?
bondholders required rate of return for holding a bond. it is the current required market rate.
If the coupon is higher than the YTM then it is a ____ bond
Discount
What is a common shareholder entitled to?
voting, share in profits, residual assets in a liquidation
Advantages of discounted payback
includes time value money, easy to understand, biased towards liquidity
Disadvantages of discounted payback
requires cut off point, ignores cash flows beyond cut-off point and may reject positive NPV investments.
Advantages of Account rate of return
easy to calculate, and needed information will usually be available
Disadvantages of Account rate of return
exclusion of time value of money, need a cut off rate and based on accounting values
Advantages of Profitability index
easy to understand and communicate, useful when investment funds are limited
Disadvantages of Profitability index
leads to incorrect decisions in comparison of mutually exclusive investments
Side effects (positive and negative)
positive: benefits to other projects
Negative: costs to other projects
should operating cash flows be pre-tax or after tax?
After-tax
What is the capital asset pricing model and what does it measure?
it defines the relationship between risk and return. We can use the CAPM to determine its expected return and expected equity on return
What two models can estimate the costs of equity?
Capital asset pricing model and dividend growth model
What are the two ways to estimate the growth in dividends?
historical growth and analysts’ forecast
How do you measure the cost of debt? is it equal to the coupon outstanding company debt?
yield to maturity // not the coupon rate
Which components of the capital structure are adjusted for taxes and why?
Debt is adjusted for taxes because only interest is tax-deductible. Companies are not allowed to adjust dividends.
In calculating the weighted average cost of capital do you use the market value or the book value?
Market value
If you one of the models and compare a cost of equity to be less than the cost of debt does this make sense?
No, because equity should have a higher return and debt since, it carries more risk to the holder.
What are you trying to minimize/maximize when you select a debt- equity ratio?
you want to minimize the cost of capital
As the firms risk increases, the cost of capital _______ and the NPV of projects __________
cost of capital INCREASES and the NPV of projects DECREASE
What does beta measure?
beta measures the systematic risk of market risk which cannot be divorced away. The risk you can’t get rid of such as things that impact all companies or economic downturns
The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is called the: a. mean. B. beta coefficient. c. risk premium. d. standard deviation. e. variance.
Beta Coeffiecient
The return on a risky asset that is anticipated in the future is called the: a. real return. b. risk premium. c. systematic return. D. expected return. e. beta.
Expected Return
Which of the following will increase the sustainable growth rate of a firm?
I. eliminating all dividends
II. increasing the target debt-equity ratio
III. increasing the profit margin
IV. increasing the total asset turnover rate
a. I, III, and IV only
B. I, II, III, and IV
c. I, II, and III only
d. I and II only
e. II, III, and IV only
I, II, III, and IV
A net present value of zero implies that an investment:
A. is earning a return that exactly matches the requirement.
b. has no initial cost.
c. never pay back its initial cost.
d. should be rejected even if the discount rate is lowered.
e. has an expected return that is less than the required return.
Is earning a return that exactly matches the requirement
A conventional cash flow is defined as a series of cash flows where:
A. The total of the cash flows is positive.
B. All of the cash flows are positive.
C. The sum of the cash flows is equal to zero.
D. The present value of the cash flows is equal to zero.
E. Only the initial cash flow is negative.
Only the initial cash flow is negative
Which of the following decision rules has the advantage that the information needed for the computation is readily available?
A. Net present value B. Internal rate of return C. Payback period D. Average accounting return E. Discounted payback
Average Accounting Return
Which of the following calculations takes the time value of money into an account?
I. Payback
II. Average accounting return
III. Profitability index
III only
The CAPM shows that the expected return for a particular asset depends on: I. The amount of unsystematic risk. II. The reward for bearing systematic risk. III. The pure time value of money. A. I only B. I and II only C. III only D. I, II, and III E. II and III only
II and III
