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FIN 701 LSUS > Module 4 > Flashcards

Module 4 Flashcards

1
Q

the number of years needed to recover the initial cash outlay of a capital budgeting project

A

Payback Period

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2
Q

If the payback period is SHORTER than the firms guidelines for pay back, do you accept or reject

A

Accept

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3
Q

selection of projects with the highest ________ will maximize the increase in shareholder wealth, the goal of the firm

A

Net Present Value (NPV)

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4
Q

equal to the present value of all future cash flows less the investments initial outlay
If positive accept
If negative reject

A

Net Present Value

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5
Q

Considered to be the most theoretically correct criterion for evaluating capital budgeting projects

A

Net Present Value

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6
Q

the ratio of the present value of the future cash flows to the initial outlay
Same acceptance/rejection decision as NPV

A

Profitability Index (PI)

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7
Q

present value of the future cash flows to the initial outlay

Gives the same accept/reject decision as NPV

A

Profitability Index (PI)

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8
Q

helpful in ranking various projects because it lets investors quantify the value created per each investment unit. 1.0 is logically the lowest acceptable measure on the index, as any value lower than that number would indicate that the project’s present value (PV) is less than the initial investment.

A

Profitability Index

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9
Q

Based solely on the estimated cash flows and is INDEPENDENT of required rate of return or other interest rates

A

Internal Rate of Return (IRR)

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10
Q

the rate that makes the present value of future cash flows equal to the initial cost of their investment.

A

Internal Rate of Return (IRR)

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11
Q

Underlying assumption of ________ is that the projects cash flows are reinvested at the projects _________

A

Internal Rate of Return (IRR)

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12
Q

cost of capital and _____________ are the same

A

Internal Rate of Return (IRR)

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13
Q

NPV=0, IRR=Required rate of return, then the PV of future cash flows exactly equals the initial outlay. PI also equals 1

A

Relationship between IRR, NPV, and PI

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14
Q

________ has a flaw, there is potential for multiple internal rates of return if the cashflows are not normal

A

Internal Rate of Return

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15
Q

The discount rate which causes the PV of a projects terminal value to equal the PV of costs. Found by compounding inflows at the cost of capital (RRR) assumes cashflows are reinvested at the RRR

A

MIRR

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16
Q

Cash Flows are compressed (earned earlier than expected, the NPV increases (improves) as to all other analysis metrics (same with increase in cash flows)

If a projects salvage value or other cash flows increase that increases expected cash flows making the projects NPV and other metrics more favorable

If the same cash flows are expected to be earned over a longer time period, NPV will decline.

If the salvage value or other cash flows decrease NPV will decline

A

how cash flow amounts timing changes affect NPV IRR PI & payback would all change

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17
Q

If the Required Rate of Return increases, the present value of future cash flows will ________ and NPV and PI will _________

A

decrease

decrease

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18
Q

refers to the potential variability in future cash flows
the wider rage of possible future events that can occur the greater the risk
returns on common stock are _______ than returns from investing in a bank savings account

A

Risk

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19
Q

The ______ the holding period, the less volatility in returns- especially for common stocks.

A

longer

volatility

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20
Q

in a one year holding period, ______ are risky compared to _______.

A

Stocks

Bonds

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21
Q

Over a one year holding period, _______ are risky compared to ______ and TBills, but over a __________ period, stocks become _________ risky compared to other investments.

A

stocks
bonds
longer
less

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22
Q

a measure of how much the individual returns on the stock move with the overall market price “market risk”

A

beta

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23
Q

a measure of how much the individual returns on the stock deviate from the expected value or the mean

A

standard deviation

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24
Q

the weighted average of the POSSIBLE cash flows outcomes such as that the weights are the probabilities of the occurrence of the carious states of the economy

A

Expected Cash Flow

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25
Q

group of investments held together, strive for diversification, characterized by included investments & the amount invested in each security

A

Portfolio concept

26
Q

the release of information not previously available , they have 2 parts the expected part and the surprise part

A

announcements

27
Q

discounted information to estimate the expected return, the surprise news influences the unexpected return

A

parts of company news and announcements

28
Q

theory states that share prices reflect all information. stocks trade at their fair market value on exchanges.
investors benefit from investing in a low-cost, passive portfolio.
Opponents of this theory believe that it is possible to beat the market and that stocks can deviate from their fair market values.

A

Efficient Market Hypothesis

29
Q

IF 2 stocks are perfectly _________ correlated diversification has ___________ on risk

A

Positively

no effect

30
Q

IF 2 stocks are perfectly _____________ correlated the portfolio is perfectly diversified

A

Negatively

31
Q

measures how closely the returns on two different stocks align

A

Correlation between assets

32
Q

if Beta is ________ the stock is expected to move in the same direction as the market

A

positive

33
Q

if Beta is __________ the stock is expected to decline in value if the market goes up and have a positive return if the market goes down

A

negative

34
Q

the statistical measure of market volatility, measuring how widely prices are dispersed from the average price. If prices trade in a narrow trading range, the return is a low value that indicates low volatility. If prices swing wildly up and down, returns are a high value that indicates high volatility.

A

Standard Deviation

35
Q

the point with __________ is that over time the unexpected increases and decreases in stock price over the short term due to “unexpected news” cancel out in the long term

A

Unexpected returns

36
Q

when positive it adds value to the frim

A

NPV

37
Q

the amount of change a proposed project will have on the value of the frim

A

NPV

38
Q

equal to zero, that means that the present value of future cash flows (discounted at the
appropriate cost of capital) is exactly equal to the initial outflows (initial outlay). This also means that the discount rate
is exactly equal to the project’s IRR or internal rate of return.

A

When NPV is equal to ZERO

39
Q

generally considered to be the “gold standard” for capital budgeting analysis, which,
by definition, is for long term projects.

A

NPV

40
Q

gives us the amount by which firm value changes

A

NPV

41
Q

gives no indication of the change in firm value.

A

IRR

42
Q

simplicity and it provides additional information to firms about fund availability for reinvestment.
Managers may rely on it more for short term and/or lower initial outlay projects

A

Payback Period

43
Q

two key drawbacks to the use of the ___________, the time value of money is ignored and all cash flows after are ignored.

A

Negatives of using the payback period

44
Q

near term cash flows will result in higher or lower NPV and IRR (all else equal)

A

Higher

45
Q

The ________ the period until receipt of cash flows, the lower the NPV and the IRR

A

Longer

46
Q

what would happen to the NPV if the initial investment in fixed assets increased?

A

NPV would decrease

47
Q

what would happen to NPV if we had a higher salvage value at the end of the project?

A

It would increase

48
Q

If the IRR= the RRR “discount rate” for the project, the NPV will be

A

ZERO- this is the relationship between NPV and IRR

49
Q

If the NPV is positive, the project will be accepted or rejected?

A

Accepted

50
Q

If the IRR is greater than the RRR/discount rate, the project will be accept or reject?

A

Accept

51
Q

If the IRR is less than the discount rate, that means NPV is Negative or positive

A

Negative

52
Q

What would happen to the IRR if the discount rate was increased or decreased?

A

NOTHING the IRR is independent of the RRR. However, the accept or reject decision could change.

53
Q

If cash flows are condensed overtime would the IRR increase or decrease
would NPV increase or decrease

A

Increase

Increase

54
Q

shows how many dollars of return a project returns for every $1

A

Profitability index

55
Q

True/ False

Firms would not impose a required return of less than $1 as this rule would accept a negative NPV project

A

True

56
Q

Beta for the overall market is 1.0

True or False

A

True

57
Q

A Beta of 1.3 means that this particular “risky” asset is 1.3 times as volatile or reactive to systematic (market wide) risk as the “average risky asset”

True or False

A

True

58
Q

risk/return or relative riskiness
a way to compare relative risk and return between different investments
a lower CV is preferred for those who are risk adverse

A

Coefficient variation

59
Q

amount of return you expect from a stock based on the risk
estimated return for a stock is LESS than ______ you reject the stock
estimated return for a stock is more than _______ you buy the stock

A

Required Rate of Return

60
Q

The ___________ is the additional return an investor will receive (or expects to receive) from holding a risky market portfolio instead of risk-free assets.

A

Market Risk Premium

61
Q

non-diversifiable risk. This risk is the fluctuation of returns caused by macroeconomic factors that affect all risky assets.

A

Systematic (Market) Risk

62
Q

risk is the risk that something goes wrong on for a company or industry such as mismanagement, labor strikes, production of undesirable products,

A

Non Systematic (Unique) Risk

FIN 701 LSUS (3 decks)

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