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RMCB Flashcards

1
Q

Theoretically, the proceeds from the sale of bond will be equal to

A

The present value of the principal amount due at the end of the life of the bond plus the present value of the interest payments made during the life of the bond, each discounted at the prevailing market rate of interest.

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2
Q

What accounts for the difference between the stated rate and the effective annual rate of loan?

A

The frequency of compounding.

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3
Q

In portfolio analysis a measure that is used to express the extent of the relationship among set of investments is the

A

Coefficient of correlation.

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4
Q

What is an internal rate of return?

A

A time-adjusted rate of return from an investment.

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5
Q

The discount rate (hurdle rate of return) must be determined in advance for the

A

Net present value method.

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6
Q

A downward-sloping yield curve depicting the term structure of interest rates implies that

A

Prevailing short-term interest rates are higher than prevailing long-term interest rates.

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7
Q

Which tool would most likely be used to determine the best course of action under conditions of uncertainty?

A

Expected value (EV).

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8
Q

The profitability index is variation on which of the following capital budgeting models?

A

Net present value.

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9
Q

Polo Co. requires higher rates of return for projects with life span greater than five years. Which of the following capital budgeting techniques can readily accommodate this requirement?

a. Payback method
b. Net present value
c. Neither
d. Payback method and Net present value

A

Net present value

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10
Q

In an interest rate swap the first company

A

Agrees to exchange with the second company the difference between the interest charges on its own borrowings and the interest charges on the borrowings of the second company.

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11
Q

Which of the following is not financial intermediary?

a. Investment banker.
b. Commercial bank.
c. Mutual fund.
d. A commercial business.

A

A commercial business.

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12
Q

Salem Co. is considering project that yields annual net cash inflows of $420,000 for years 1 through 5, and a net cash inflow of $100,000 in year 6. The project will require an initial investment of $1,800,000. Salem’s cost of capital is 10%. Present value information is presented below.

Present value of $1 for 5 years at is .62.

Present value of $1 for 6 years at is .56.

Present value of an annuity of $1 for 5 years at 10% is 3.79.

What was Salem’s expected net present value for this project?

A

$(152,200)

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13
Q

Harvey Co. is evaluating capital investment proposal for new machine. The investment proposal shows the following information:

Initial cost $500,000

Life 10 years

Annual net cash $200,000

Salvage value $100,000

If acquired, the machine will be depreciated using the straight-line method. The payback period for this investment is

A

2.5 years

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14
Q

Which of the following is disadvantage of the internal rate of return as method of evaluating investments?

a. Does not consider the profitability of the project.
b. Does not adjust for the time value of money.
c. Has limitations when evaluating mutually exclusive investments.
d. Its results are not intuitive.

A

Has limitations when evaluating mutually exclusive investments.

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15
Q

Essex Corporation is evaluating lease that takes effect on March 1, 2012. The company must make eight equal payments, with the first payment due on March 1, 2012. The concept most relevant to the evaluation of the lease is

A

The present value of an annuity due.

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16
Q

Use the following information to answer this question.

Investment project Cash outlay Present value of cash inflows

A $1,100,000 $ 980,000

B 250,000 600,000

C 1,400,000 $1,830,000

D 650,000 790,000

The company has $2,000,000 of financing available for new investment projects. If only one project may be selected, which should the company undertake?

A

Project C.

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17
Q

A company is considering exchanging an old asset for new asset. Ignoring income tax considerations, which of the following is economically relevant to the decision?

a. Original cost of old asset and Fair market value of old asset
b. Original cost of old asset
c. Fair market value of old asset
d. Neither

A

Fair market value of old asset

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18
Q

According to the expectations theory of the term structure of interest rates, if inflation is expected to increase, the yield curve is

A

Upward sloping.

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19
Q

Which of the following events would decrease the internal rate of return of proposed asset purchase?

a. Use accelerated, instead of straight-line depreciation.
b. Decrease related working capital requirements.
c. Decrease tax credits on the asset.
d. Shorten the payback period.

A

Decrease tax credits on the asset.

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20
Q

At the beginning of year I, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for year 2?

A

$864.00

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21
Q

The zero-coupon method is used to determine the fair value of

A

Interest rate swaps.

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22
Q

If management has variable rate short-term loan and is concerned about the volatility of short-term interest rates, which of the following would not be an effective hedging strategy?

a. Enter into an interest rate swap.
b. Enter into a forward contract to sell Treasury bonds in the future.
c. Enter into a forward contract to purchase Treasury bills in the future.
d. Purchase a short position in the Treasury bill futures market.

A

Enter into a forward contract to purchase Treasury bills in the future.

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23
Q

Use the following information to answer this question.

Investment project Cash outlay Present value of cash inflows

A $1,100,000 $ 980,000

B 250,000 600,000

C 1,400,000 $1,830,000

D 650,000 790,000

The company has $2,000,000 of financing available for new investment projects. The investment project with the highest excess profitability index is

A

Project B

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24
Q

Which of the following statements about investment decision models is true?

a. The internal rate of return rule is to accept the investment if the opportunity cost of capital is greater than the internal rate of return.
b. The payback rule ignores all cash flows after the end of the payback period.
c. The net present value model says to accept investment opportunities when their rates of return exceed the company’s incremental borrowing rate.
d. The discounted payback rate takes into account cash flows for all periods.

A

The payback rule ignores all cash flows after the end of the payback period.

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25
Q

It is assumed that cash flows are reinvested at the rate earned by the investment in which of the following capital budgeting techniques?

a. Internal rate of return and Net present value
b. Internal rate of return
c. Neither
d. Net present value

A

Internal rate of return

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26
Q

The calculation of depreciation is used in the determination of the net present value of an investment for which of the following reasons?

a. The decline in the value of the investment should be reflected in the determination of net present value.
b. Depreciation represents cash outflow that must be added back to net income.
c. Depreciation increases cash flow by reducing income taxes.
d. Depreciation adjusts the book value of the investment.

A

Depreciation increases cash flow by reducing income taxes.

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27
Q

Net present value (NPV) and internal rate of return (IRR) differ in that

A

NPV assumes reinvestment of project cash flows at the cost of capital while IRR assumes reinvestment of project cash flows at the internal rate of return.

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28
Q

Which of the following describes the derivative risk that relates to the possibility of loss from regulatory action?

a. Basis risk.

b Market risk.

c. Credit risk.
d. Legal risk.

A

Legal risk

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29
Q

Which of the following statements is correct regarding payback method as a capital budgeting technique?

a. The payback method provides the years needed to recoup the investment in a project.
b. Payback is calculated by dividing the annual cash inflows by the net investment.
c. The payback method considers the time value of money.
d. An advantage of the payback method is that it indicates if an investment will be profitable.

A

The payback method provides the years needed to recoup the investment in a project.

30
Q

Warren, Inc. is considering number of methods to evaluate investment projects. Management of Warren is primarily concerned with maximizing shareholder value. Which of the following techniques would probably be the best method for management of Warren to select?

a. Payback.
b. Discounted payback.
c. Accounting rate of return.
d. Net present value.

A

Net present value.

31
Q

A project has an initial outlay of $1,000. The projected cash inflows are

Year 1 $200

Year 2 200

Year 3 400

Year 4 400

What is the investment’s payback period?

A

3.5 years

32
Q

Which of the following is an advantage of net present value modeling?

a. It is measured in time, not dollars.
b. It uses accrual basis, not cash basis accounting for project.
c. It accounts for compounding of returns.
d. It uses the accounting rate of return.

A

It accounts for compounding of returns.

33
Q

Which of the following rates is most commonly compared to the internal rate of return to evaluate whether to make an investment?

a. Prime rate of interest.
b. Long-term rate on US Treasury bonds.
c. Weighted-average cost of capital.
d. Short-term rate on US Treasury bonds.

A

Weighted-average cost of capital.

34
Q

In statistical analysis, weighted-average using probabilities as weights is the

A

Expected value.

35
Q

An efficient portfolio is one that

A

One that meets the investor’s tradeoff between risk and return.

36
Q

An American importer expects to pay British supplier 500,000 British pounds in three months. . Which of the following hedges is best for the importer to fix the price in dollars?

a. Buying British pound put options.
b. Buying British pound call options.
c. Selling aritish pound call options.
d. Selling British pound put options

A

Buying British pound call options.

37
Q

Which of the following does investment’s beta measure?

a. The investment’s interest rate risk.
b. The investment’s systematic risk.
c. The investment’s default risk.
d. The investment’s unsystematic risk.

A

The investment’s systematic risk.

38
Q

The Bread Company is planning to purchase new machine which it will depreciate on a straight-line basis over a 10-year period. A full year’s depreciation will be taken in the year of acquisition. The machine is expected to produce cash flow from operations, net of income taxes, of $3,000 in each of the 10 years. The accounting (book value) rate of return is expected to be 10% on the initial increase in required investment. The cost of the new machine will be

A

$15,000

39
Q

Which of the following best describes sensitivity analysis?

a. A technique that views an investment as purchasing an option.
b. A technique that explores the importance of assumptions underlying a forecast.
c. A technique that explores the effect of simultaneous changes in group of variables.
d. A technique that recognizes the multiple decisions that are involved in implementing project.

A

A technique that explores the importance of assumptions underlying a forecast.

40
Q

Which of the following limitations is common to the calculations of payback period, discounted cash flow, internal rate of return, and net present value?

a. They require knowledge of a company’s cost of capital.
b. They do not consider the time value of money.
c. They require multiple trial and error calculations.
d. They rely on the forecasting of future data.

A

They rely on the forecasting of future data.

41
Q

Assume that management of Trayco has generated the following data about an investment project that has five-year life:

Initial investment $100,000

Additional investment in working capital 5,000

Cash flows before income taxes for

years I through 5 30,000

Yearly depreciation for tax purposes 20,000

Terminal value of machine 0

Cost of capital 8%

Present value of $1received after 5

years discounted at 8% .681

Present value of an ordinary annuity

of $1 for 5 years at 8% 3.993

Assume that Trayco’s marginal tax rate is 30% and all cash flows come at the end of the year. In evaluating the decision how is the additional investment in working capital considered?

A

As an additional initial investment that will be recovered at the end of year 5.

42
Q

What is the formula for calculating the profitability index of project?

A

Divide the present value of the annual after-tax cash flows by the original cash invested in the project.

43
Q

Which of the following changes would result in the highest present value?

a. A $100 increase in disposal value at the end of four years.
b. A $100 decrease in taxes each year for four years.
c. A $100 decrease in the cash outflow each year for three years.
d. A $100 increase in cash inflow each year for three years.

A

A $100 decrease in taxes each year for four years.

44
Q

Which of the following describes an option?

a. A standardized contract to take delivery of specified quantity of financial instrument in the future.
b. An agreement to swap a stream of cash flows.
c. A negotiated contract to purchase a specified quantity of a financial instrument in the future.
d. A contract that allows the holder to purchase specified quantity of financial instrument at specified price.

A

A contract that allows the holder to purchase specified quantity of financial instrument at specified price.

45
Q

A multiperiod project has a positive net present value. Which of the following statements is correct regarding its required rate of return?

a. Greater than the company’s weighted-average cost of capital.
b. Less than the project’s internal rate of return.
c. Greater than the project’s internal rate of return.
d. Less than the company’s weighted-average cost of capital.

A

Less than the project’s internal rate of return.

46
Q

Under frost-free conditions, Ball Cultivators expects its strawberry crop to have a $120,000 market value. An unprotected cap subject to frost has an expected market value of $80,000. If Ball protects the strawberries against frost, then the market value of the crop is still expected to be $120,000 under frost-free conditions and $180,000 if there is a frost. What must be the probability of frost for Ball to be indifferent to spending $20,000 for frost protection?

A

.200

47
Q

In considering the payback period for three projects, Fly Corp. gathered the following data about cash flows:

                             Cash Flows by Year

                Year 1       Year 2      Year 3     Year 4     Year 5

Project A $(10,000) $3,000 $3,000 $3,000 $3,000

Project B (25,000) 15,000 15,000 (10,000) 15,000

Project C (10,000) 5,000 5,000

Which of the projects will achieve payback within three years?

A

Projects B and C

48
Q

Kipling Company invested in an 8-year project. It is expected that the annual cash flow from the project, net of income taxes, will be $20,000. Information on present value factors is as follows:

Present value of $1 at 12% for eight periods 0.404

Present value of an ordinary annuity of $1

at 12% for eight periods 4.968

Assuming that Kipling based its investment decision on an internal rate of return of 12%, how much did the project cost?

A

$99,360

49
Q

A project has present value of future net cash inflows of $120,000 and an initial investment of $110,000. Calculate the excess present value index for the project.

A

109.1%.

50
Q

Which of the following characteristics represent an advantage of the internal rate of return technique over the accounting rate of return technique in evaluating project ?

I. Recognition of the project’s salvage value.

Il. Emphasis on cash flows.

Ill. Recognition of the time value of money.

A

II and III

51
Q

Which of the following formulas should be used to calculate the economic rate of return on common stock?

a. Dividends per share divided by market price per share.
b. (Net income - preferred dividend) divided by common shares outstanding.
c. Market price per share divided by earnings per share.
d. (Dividends + change in price) divided by beginning price.

A

(Dividends + change in price) divided by beginning price.

52
Q

Which of the following statements is correct regarding financial decision making?

a. A strength of the payback method is that it is based on profitability.
b. The accounting rate of return considers the time value of money.
c. Capital budgeting is based on predictions of an uncertain future.
d. Opportunity cost is recorded as normal business expense.

A

Capital budgeting is based on predictions of an uncertain future.

53
Q

Williams Distributors has decided to increase its daily muffin purchases by 100 boxes. A box of muffins costs $4 and sells for $6 through regular stores. Any boxes not sold through regular stores are sold through Dough’s thrift store for $3. Williams assigns the following probabilities to selling additional boxes:

Additional sales Probability

60 .6

100 .4

What is the expected value of Dough’s decision to buy 100 additional boxes of muffins?

A

$128

54
Q

On January 1, 2012, Colt Company issued 10-year bonds with a face amount of $1,000,000 and stated interest rate of 8% payable annually on January 1. The bonds were priced to yield 10%. Present value factors are as follows:

                                                       At 8%        At 10%

Present value of I for 10 periods 0.463 0.386

Present value of an ordinary

annuity of I for 10 periods 6.710 6.145

The total issue price (rounded) of the bonds was

A

$ 877,600

55
Q

The variance of an individual investment captures

A

Both systematic risk and unsystematic risk.

56
Q

Assume that management of Trayco has generated the following data about an investment project that has five-year life:

Initial investment $100,000

Additional investment in working capital 5,000

Cash flows before income taxes for

years I through 5 30,000

Yearly depreciation for tax purposes 20,000

Terminal value of machine 0

Cost of capital 8%

Present value of $1received after 5

years discounted at 8% .681

Present value of an ordinary annuity

of $1 for 5 years at 8% 3.993

Assume that Trayco’s marginal tax rate is 30% and all cash flows come at the end of the year. Calculate the net present value of the investment of the project.

A

$6,216

57
Q

Which of the following scenarios would encourage company to use short-term loans to retire its ten-year bonds that have five years until maturity?

a. The company is experiencing cash flow problems.
b. The company expects interest rates to increase over the next five years.
c. Interest rates have increased over the last five years.
d. Interest rates have declined over the last five years.

A

Interest rates have declined over the last five years.

58
Q

Which of the following techniques consistently gives the best answer when evaluating investment projects that are mutually exclusive?

a. The payback method.
b. The internal rate of return.
c. The accounting rate of return.
d. Net present value.

A

Net present value.

59
Q

A company purchases an item for $43,000. The salvage value of the item is $3,000. The cost of capital is 8%. Pertinent information related to this purchase is as follows:

             Net cash flows     Presents value factor at 8%

Year 1 $10,000 0.926

Year 2 15,000 0.857

Year 3 20,000 0.794

Year 4 27,000 0.735

What is the discounted payback period in years?

A

3.25

60
Q

How are the following used in the calculation of the net present value of proposed project? Ignore income tax considerations.

 Depreciation expense    Salvage value

a. Include Include
b. Include Exclude
c. Exclude Include
d. Exclude Exclude

A

Exclude Include

61
Q

Which of the following describes normal yield curve?

a. Upward sloping.
b. Downward sloping.
c. Humped.
d. Flat

A

Upward sloping.

62
Q

Assume that management of Trayco has generated the following data about an investment project that has five-year life:

Initial investment $100,000

Additional investment in working capital 5,000

Cash flows before income taxes for

years I through 5 30,000

Yearly depreciation for tax purposes 20,000

Terminal value of machine 0

Cost of capital 8%

Present value of $1received after 5

years discounted at 8% .681

Present value of an ordinary annuity

of $1 for 5 years at 8% 3.993

Assume that Trayco’s marginal tax rate is 30% and all cash flows come at the end of the year. What is the amount of the after tax cash flow in year 2?

A

$27,000

63
Q

Which of the following statements is true regarding the payback method?

a. The salvage value of old equipment is ignored in the event of equipment replacement.
b. It is the time required to recover the investment and earn profit.
c. It does not consider the time value of money.
d. It is a measure of how profitable one investment project is compared to another.

A

It does not consider the time value of money.

64
Q

Assume that Velmont Corp. is considering investing in project with the following possible outcomes and related probabilities.

Outcome (present value of future cash flows) Probability

$200,000 .4

$300,000 .3

$400,000 .3

Calculate the expected return of the investment.

A

$290,000

65
Q

Net present value as used in investment decision-making is stated in terms of which of the following options?

a. Earnings before interest, taxes, and depreciation.
b. Cash flow.
c. Earnings before interest and taxes.
d. Net income.

A

Cash flow.

66
Q

A company is arranging financing for the purchase of a new piece of equipment that has a five-year expected useful life. Which of the following alternative financing arrangements has the lowest effective annual percentage rate if each has a quoted nominal rate of 9.5%.

a. A ten-year term loan with interest compounded monthly.
b. A five-year term loan with interest compounded quarterly.
c. A five-year term loan with interest compounded annually.
d. A ten-year term loan with interest compounded semiannually.

A

A five-year term loan with interest compounded annually.

67
Q

Which of the following factors does not affect the variance of portfolio?

a. The percentage of the portfolio invested in each asset.
b. The covariance among the returns of assets in the portfolio.
c. The expected market rate.
d. The variance of the returns on each individual asset.

A

The expected market rate.

68
Q

Which of the following is necessary in order to calculate the payback period for project?

a. Minimum desired rate of return.
b. Annual cash flow.
c. Useful life.
d. Net present value.

A

Annual cash flow.

69
Q

Which of the following decision-making models equates the initial investment with the present value of the future cash inflows?

a. Cost-benefit ratio.
b. Internal rate of return.
c. Accounting rate of return.
d. Payback period.

A

Internal rate of return.

70
Q

Axel Corp. is planning to buy new machine with the expectation that this investment should earn discounted rate of return of at least 15%. This machine, which costs $150,000, would yield an estimated net cash flow of $30,000 a year for 10 years, after income taxes. In order to determine the net present value of buying the new machine, Axel should first multiply the $30,000 by which of the following factors?

a. 20.304 (Future amount of an ordinary annuity of $1).
b. 0.247 (Present value of $1).
c. 4.046 (Future amount of $1).
d. 5.109 (Present value of an ordinary annuity of $1).

A

5.109 (Present value of an ordinary annuity of $1).

71
Q

A client wants to know how many years it will take before the accumulated cash flows from an investment exceed the initial investment, without taking the time value of money into account. Which of the following financial models should be used?

a. Net present value.
b. Payback period.
c. Discounted payback period.
d. Internal rate of return.

A

Payback period.

Business Environment (8 decks)

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