Finance 3716 Final

A capital budget lists the potential projects a company may undertake in future years. T/F False
Capital Budgeting decisions use the net present value rule so that those decisions maximize net present value. T/F False
The ultimate goal of the capital budgeting process is to ________.A) determine how the consequences of making a particular decision affects the firm’s revenues and costsB) list the projects and investments that a company plans to undertake in the futureC) forecast the consequences of a list of future projects for the firmD) determine the effect of the decision to accept or reject a project on the firm’s cash flows D
The capital budgeting process begins by ________.A) analyzing alternate projects B) evaluating the net present value (NPV) of each project’s cash flows C) compiling a list of potential projectsD) forecasting the future consequences for the firm of each potential project C
Which of the following best defines incremental earnings?A) cash flows arising from a particular investment decisionB) the amount by which a firm’s earnings are expected to change as a result of an investment decisionC) the earnings arising from all projects that a company plans to undertake in a fixed time spanD) the net present value (NPV) of earnings that a firm is expected to receive as the result of an investment decision B
Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?A) They do not tell how the decision affects the firm’s reported profits from an accounting perspective.B) They are not easily predicted from historical financial statements of a firm and its competitors.C) These earnings are not actual cash flows.D) They do not show how the firm’s earnings are expected to change as the result of a particular decision. C
When evaluating the effectiveness of an improved manufacturing process we should evaluate the total sales and costs generated by this process. T/F False
Interest and other financing-related expenses are excluded when determining a project’s unlevered net income. T/F True
Cameron Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $6 million to buy the machine and $10,000 to have it delivered and installed. Building a clean room in the plant for the machine will cost an additional $3 million. The machine is expected to have a working life of six years. Which of these activities will be reported as an operating expense?A) the delivery and install cost onlyB) the cost of the depositor onlyC) the redesign of the plant onlyD) the delivery and install cost and the cost of the depositor C
Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product?A) the fluctuations in the cost of capital over the period in questionB) the sales of a new product will typically accelerate, plateau, and ultimately decline over timeC) the prices of technology products generally fall over timeD) competition tends to reduce profit margins over time in most industries A
Which of the following is NOT a factor that a manager should bear in mind when estimating a project’s revenues and costs?A) Sales of a product will typically accelerate, stabilize, and then decline as the product becomes outdated or faces increased competition.B) A new product typically has its highest sales immediately after release as customers are attracted by the novelty of the product.C) The prices of technology products tend to fall over time as newer, superior technologies emerge and production costs decline. D) Prices and costs tend to rise with the general level of inflation in the economy. B
The discounted free cash flow model ignores interest income and expense but adjusts for cash and debt directly, if free cash flow is calculated based on EBIT. T/F True
If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the ________.A) enterprise value modelB) method of comparablesC) dividend-discount modelD) discounted free cash flow model C
If you want to value a firm but do not want to explicitly forecast its dividends, the simplest model for you to use is ________.A) the discounted free cash flow modelB) the dividend-discount modelC) the enterprise value modelD) None of the above models can be used if you do not want to forecast dividends or use of debt. A
Which of the following statements is FALSE?A) The more cash a firm uses to repurchase shares, the less it has available to pay dividends.B) Free cash flow measures the cash generated by a firm after payments to debt or equity holders are considered.C) We estimate a firm’s current enterprise value by computing the present value (PV) of the firm’s free cash flow.D) We can interpret the enterprise value of a firm as the net cost of acquiring the firm’s equity, taking its cash, and paying off all debts. B
Which of the following statements is FALSE?A) A firm’s weighted average cost of capital, denoted rwacc, is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm’s equity and debt.B) Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model, a firm’s cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model.C) We interpret rwacc as the expected return a firm must pay to investors to compensate them for the risk of holding the firm’s debt and equity together.D) When using the discounted free cash flow model, we should use a firm’s equity cost of capital. D
Which of the following statements is FALSE?A) The long-run growth rate gFCF is typically based on the expected long-run growth rate of a firm’s revenues.B) Since a firm’s free cash flow is equal to the sum of the free cash flows from the firm’s current and future investments, we can interpret the firm’s enterprise value as the total net present value (NPV) that the firm will earn from continuing its existing projects and initiating new ones.C) If a firm has no debt, then rwacc equals the risk-free rate of return.D) When using the discounted free cash flow model, we forecast a firm’s free cash flow up to some horizon, together with some terminal (continuation) value of the enterprise. C
In the method of comparables, the known values of a firm’s cash flows are used to estimate the unknown cash flows of a similar firm. T/F True
Several methods should be used to provide an estimate of a stock’s value since no single method provides a definitive value. T/F True
Which of the following statements concerning the valuation of firms using the method of comparables is FALSE?A) If two different firms generate identical cash flows, the Law of One Price will imply that both firms have the same value.B) Comparables adjust for scale differences when valuing similar firms.C) Valuation multiples take into account differences in the risk and future growth between the firms being compared.D) Two firms that sell very similar products or offer very similar services will have different values if they are of different sizes. C
An investor estimates the value of a firm which manufactures cookware by examining the cash flows of similar firms. Which of the following is assumed to be the same for these firms?A) P/EB) annual growth ratesC) payout ratesD) all of the above D
Which of the following is NOT an advantage of the valuation multiple method as compared to the discounted cash flow method?A) calculations based upon widely available informationB) based upon actual stock prices of real firmsC) does not rely on estimates of future cash flowsD) takes into account important differences between different firms D
Which of the following statements is FALSE?A) Even two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale.B) In the method of comparables, we estimate the value of a firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future.C) Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm.D) A valuation multiple is a ratio of some measure of a firm’s scale to the value of the firm. D
Which of the following statements is FALSE?A) The most common valuation multiple is the price-earnings ratio.B) You should be willing to pay proportionally more for a stock with lower current earnings.C) A firm’s price-earnings ratio is equal to the share price divided by its earnings per share.D) The intuition behind the use of the price-earnings ratio is that when you buy a stock, you are in a sense buying the rights to the firm’s future earnings, and differences in the scale of firms’ earnings are likely to persist. B
Which of the following statements is FALSE?A) We can estimate the value of a firm’s shares by multiplying its current earnings per share by the average price-earnings ratio of comparable firms.B) For valuation purposes, the trailing price-earnings ratio is generally preferred, since it is based on actual not expected earnings.C) Forward earnings are the expected earnings over the coming 12 months.D) Trailing earnings are the earnings over the previous 12 months. B
Which of the following statements is FALSE?A) As the enterprise value represents the entire value of a firm before the firm pays its debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows after interest payments are made.B) We can compute a firm’s price-earnings ratio by using either trailing earnings or forward earnings with the resulting ratio called the trailing price-earnings or forward price-earnings.C) It is common practice to use valuation multiples based on a firm’s enterprise value.D) Using a valuation multiple based on comparables is best viewed as a “shortcut” to the discounted cash flow method of valuation. A
If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is under-valued. T/F False
In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors. T/F True
Which of the following is the best statement of the efficient markets hypothesis?A) Investors with information that a stock had a positive net present value (NPV) will buy it, while investors with information that a stock had a negative net present value (NPV) will sell it.B) Investor’s decisions are dependent on complete current information of a firm’s cash flows and accurate predictions of future cash flows.C) Competition between investors works to make the net present value (NPV) of all trading opportunities zero.D) A share’s price is the aggregate of the information of many investors. C
On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%. Which of the following is the LEAST likely consequence of such an announcement?A) The price of the stock would rise.B) Investors would determine that the estimates of the firm’s value on the date prior to the announcement were too high.C) Investors would increase their forecast of future cash flows in that firm.D) Investors would revise their estimates of the net present value (NPV) of the firm. B
Individual investors trade conservatively, given the difficulty of finding over-valued and under-valued stocks. T/F False
Individual investors who grow up and live during a time of high stock returns are more likely to invest in stocks. T/F True
Individual investors’ tendency to trade too much based on the mistaken belief that they can pick winners and losers better than investment professionals is known as ________.A) the disposition effectB) the investor attention hypothesisC) the investor overconfidence hypothesisD) the excessive trading costs hypothesis C
A study of trading behavior of individual investors at a discount brokerage found that individual investors ________.A) trade very actively, despite the fact that their performance is actually worse because of trading costsB) trade very conservatively, despite the fact that their performance is actually worse because of trading costsC) trade very actively, partly because their performance is better than the professionals’ due to low trading costsD) trade very conservatively, partly because their performance is better than the professionals’ due to low trading costs A
Disposition effect is the tendency of individual investors to ________.A) trade too much based on the mistaken belief that they can pick winners and losers better than investment professionalsB) buy stocks that have been in the news, advertised more, have very high trading volume, or recently had extreme (high or low) returnsC) put too much weight on their own experience rather than considering historical evidenceD) hold on to stocks that have lost value and sell stocks that have risen in value since the time of purchase D
On average, stocks have delivered higher returns than bonds in the long run. T/F True
In the United States over the long term, small stocks have provided the highest return followed by the large stocks in the S&P 500. T/F True
Rational investors ________ fluctuations in the value of their investments.A) are averse toB) preferC) are indifferent toD) are in favor of A
Stocks with high returns are expected to have ________.A) high variabilityB) low variabilityC) no relation to variabilityD) inverse relationship with variability A
Historically, stocks have delivered a ________ return on average compared to Treasury bills but have experienced ________ fluctuations in values. A) higher, higherB) higher, lowerC) lower, higherD) lower, lower A
Investors demand a higher return for investments that have larger fluctuations in values because ________.A) they do not like riskB) they are risk seekingC) they invest for the long termD) they prefer fluctuations A
Which of the following investments offered the lowest overall return over the past eighty years?A) small stocksB) Treasury billsC) S&P 500D) corporate bonds B
Which of the following investments offered the highest overall return over the past eighty years?A) Treasury billsB) S&P 500C) small stocksD) corporate bonds C
Which of the following investments had the largest fluctuations overall return over the past eighty years?A) small stocksB) S&P 500C) corporate bondsD) Treasury bills A
If returns on stock A are more volatile than the returns on stock B, the geometric average return of stock A will be ________ the geometric average return of stock B when their arithmetic average returns are same.A) same asB) higher thanC) lower thanD) always same as C
The standard deviation of returns of ________.I. small stocks is higher than that of large stocksII. large stocks is lower than that of corporate bondsIII. corporate bonds is higher than that of Treasury billsWhich statement is true?A) I and IIIB) I, II, and IIIC) I and IID) I only A
If asset A’s return is exactly two times asset B’s return, then following risk return tradeoff, the standard deviation of asset A should be ________ times the standard deviation of asset B.A) 3B) 2C) 1D) 4 B
Which of the following statements is FALSE?A) The geometric average return is a better description of the long-run historical performance of an investment.B) The geometric average return will always be above the arithmetic average return, and the difference grows with the volatility of the annual returns.C) The compounded geometric average return is most often used for comparative purposes.D) We should use the arithmetic average return when we are trying to estimate an investment’s expected return over a future horizon based on its past performance. B
Rational investors may be willing to choose an investment that has additional risk but does not offer additional reward. T/F False
Historical evidence on the returns of large portfolios of stock and bonds shows that investments with higher volatility have rewarded investors with higher returns. T/F True
There is a clear link between the volatility of returns for individual stocks and the returns for individual stocks. T/F False
While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return. A) volatility, volatilityB) the mean return, standard deviationC) mode, volatilityD) mode, mean return A
There is an overall relationship between ________ and ________. Larger stocks have a lower volatility overall.A) size, riskB) mean, standard deviationC) risk aversion, sizeD) volatility, mean A
The excess return is the difference between the average return on a security and the average return for ________.A) Treasury bondsB) a portfolio of securities with similar riskC) a broad-based market portfolio like the S&P 500 indexD) Treasury bills D
Which of the following statements is FALSE?A) Expected return should rise proportionately with volatility.B) Investors would not choose to hold a portfolio that is more volatile unless they expected to earn a higher return.C) Smaller stocks have lower volatility than larger stocks.D) The largest stocks are typically more volatile than a portfolio of large stocks. C
Which of the following statements is FALSE?A) Investments with higher volatility have rewarded investors with higher average returns.B) Investments with higher volatility should have a higher risk premium and, therefore, higher returns.C) Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.D) Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on. C
Which of the following statements is FALSE?A) On average, larger stocks have higher volatility than smaller stocks.B) Portfolios of large stocks are typically less volatile than individual large stocks.C) On average, smaller stocks have higher returns than larger stocks.D) On average, Treasury Bills have lower returns than corporate bonds. A
Which of the following statements is TRUE?A) On average, smaller stocks have lower volatility than Treasury bills.B) Portfolios of smaller stocks are typically less volatile than individual small stocks.C) On average, smaller stocks have lower returns than larger stocks.D) On average, Treasury bills have higher returns than stocks. B
The risk that inflation rates are likely to increase in the next year is an example of common risk. T/F True
A portfolio of stocks where each stock has a large component of independent risk benefits when such stocks are held in a portfolio, because the independent risks are averaged out. This is also referred to as diversification of risks. T/F True
A portfolio of stocks can achieve diversification benefits if the stocks that comprise the portfolio are ________.A) not perfectly positively correlatedB) perfectly correlatedC) susceptible to common risks onlyD) both B and C A
Two slot machines offer to double your money 3 times out of 5. Machine A takes $10 bets and Machine B takes $100 bets on each occasion. A risk-averse investor prefers to bet on ________.A) Machine AB) Machine BC) does not matterD) none of the above A
The risk that is linked across outcomes is called ________.A) diversifiable riskB) common riskC) uncorrelated riskD) independent risk B
Independent risks can be diversified by holding a large number of uncorrelated assets with independent risks. T/F True
A stock whose return does not depend on overall economic conditions has a low systematic risk. T/F False
Investors should earn a risk premium for bearing unsystematic risk. T/F False
In general, it is possible to eliminate ________ risk by holding a large portfolio of assets. A) unsystematicB) systematicC) unsystematic and systematicD) market specific A
A company’s stock price jumped when it announced that its revenue had decreased because of the quality issues of its products. This is an example of ________.A) market riskB) unsystematic riskC) systematic riskD) undiversifiable risk B
As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio ________.A) increasesB) remains unchangedC) decreasesD) doubles C
Because investors can eliminate unsystematic risk “for free” by diversifying their portfolios, they ________.A) do not require a risk premium for bearing itB) require a risk premium for bearing itC) are indifferent about credit spread and risk premiumD) do not require a credit spread A
The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk.A) systematic, undiversifiableB) systematic, unsystematicC) undiversifiable, diversifiableD) diversifiable, undiversifiable B
When investing for a long term, investors care about the volatility of ________ returns and not the volatility of ________ returns.A) average, cumulativeB) cumulative, averageC) mean, cumulativeD) mean, average B
Many former employees at AlphaEnergy, an energy trading and supply company, had a large part of their portfolio invested in AlphaEnergy’s stock. These employees were bearing a high degree of ________ risk.A) unsystematicB) systematicC) market-specificD) non-diversifiable A
Which of the following is NOT a diversifiable risk?A) the risk that oil prices rise, increasing production costsB) the risk that the CEO is killed in a plane crashC) the risk of a key employee being hired away by a competitorD) the risk of a product liability lawsuit A
Which of the following is NOT a systematic risk?A) the risk that oil prices rise, increasing production costsB) the risk that the economy slows, reducing demand for your firm’s productsC) the risk that your new product will not receive regulatory approvalD) the risk that the Federal Reserve raises interest rates C
Fluctuations of a stock’s return that are due to market-wide news representing common risk is the ________.A) idiosyncratic riskB) systematic riskC) unique riskD) unsystematic risk B
The risk premium of a stock is NOT affected by its ________.A) undiversifiable riskB) market riskC) systematic riskD) unsystematic risk D
Which of the following statements is FALSE?A) The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.B) When we combine many stocks in a large portfolio, the firm-specific risks for each stock will average out and be diversified.C) Fluctuations of a stock’s return that are due to firm-specific news are common risks.D) The volatility in a large portfolio will decline until only the systematic risk remains. C
If the Federal Reserve were to change from an expansionary to a contractionary monetary policy, this would be an example of ________.A) unsystematic riskB) systematic riskC) independent riskD) diversification risk B
Independent risk is more closely related to ________.A) unsystematic riskB) systematic riskC) common riskD) diversification risk A
The risk premium of a stock is not affected by its ________.A) undiversifiable riskB) typical riskC) systematic riskD) unsystematic risk D
Which of the following statements is FALSE?A) We begin the capital budgeting process by determining the incremental earnings of a project.B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre-tax income.C) Investments in plant, property, and equipment are directly listed as expense when calculating earnings.D) The opportunity cost of using a resource is the value it could have provided in its best alternative use. C
Which of the following statements is FALSE?A) Many projects use a resource that the company already owns.B) When evaluating a capital budgeting decision, we generally include interest expense.C) Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project.D) As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings. B
Which of the following costs would you consider when making a capital budgeting decision?A) sunk costB) opportunity costC) interest expenseD) fixed overhead cost B
Which of the following would you NOT consider when making a capital budgeting decision?A) the additional taxes a firm would have to pay in the next yearB) the cost of a marketing study completed last yearC) the opportunity to lease out a warehouse instead of using it to house a new production lineD) the change in direct labor expense due to the purchase of a new machine B
Which of the following is an example of cannibalization?A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line.B) A grocery store begins selling T-shirts featuring the local university’s mascot.C) A basketball manufacturer adds basketball hoops to its product line.D) A convenience store begins selling pre-paid cell phones. A
To evaluate a capital budgeting decision, it is sufficient to determine its consequences for the firm’s earnings. T/F False
The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital. T/F True
Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?A) adding depreciationB) adding all non-cash expensesC) subtracting increases in Net Working CapitalD) subtracting depreciation expenses from taxable earnings D
Firms should use the most accelerated depreciation scheme allowable. T/F True
An announcement by the government that they will decrease corporate marginal tax rates in the future would increase the attractiveness of MACRS depreciation. T/F False
The term “cannibalization” refers to ________. A) decrease in the sales of current project caused by the launching of new projectB) decrease in the sunk cost caused by launching of new projectC) decrease in overhead expenses incurred due to launch of new projectD) cost of using a resource for the best value it could provide in its best alternative A
A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation. The $20 million should best be considered ________.A) as a sunk costB) as an opportunity costC) as a fixed overhead expenseD) as a capital cost A
Joe pre-orders a non-refundable movie ticket. He then reads a number of reviews of the movie in question that make him realize that he will not enjoy it. He goes to see it anyway, rationalizing that otherwise his money will have been wasted. Is Joe succumbing to the Sunk Cost Fallacy, and why?A) Yes, since he invested a valuable asset, his time, in a project based on its previous costs.B) No, because the cost of the movie was not recoverable and would have been lost whatever action he took.C) No, because going to see the movie means that the product of his initial investment was realized as originally planned.D) Yes, because he incurred no further costs by going to see the movie. A
An insurance office owns a large building downtown. The sixth floor of this building currently houses its entire Human Resources Department. After carrying out a survey to see whether the sixth floor could be rented and for what price, the company must decide whether to split the Human Resources Department between currently unoccupied spaces on several floors and rent out the entire sixth floor or to leave things as they currently are. Which of the following should NOT be considered when deciding whether to rent out the sixth floor?A) the amount obtained by renting the sixth floorB) the cost of refurbishing the new space to be occupied by the Human Resources DepartmentC) cost involved with a loss of efficiency resulting from the Human Resources Department being split between several spacesD) the cost of the research into the feasibility of renting the sixth floor D
Which of the following is an example of cannibalization? A) A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda) to its product line. B) A grocery store begins selling T-shirts featuring the local university’s mascot. C) A basketball manufacturer adds basketball hoops to its product line.D) A convenience store begins selling pre-paid cell phones A
Which of the following best explains why is it sensible for a firm to use an accelerated depreciation schedule such as MACRS rather than straight-line depreciation?A) The firm will substantially decrease its depreciation tax shield across all of the depreciation timeline.B) The firm can decide over how many years an item may be depreciated, thus allowing it full control of its depreciation expenses.C) The firm will have substantially fewer depreciation expenses later in the depreciation timeline.D) The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV). D
The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital. T/F True
The manufacturer of a brand of kitchen knives is investigating the likely effects that an increase in the cost of the raw materials required to make these knives will have on the cost of manufacturing the knives, the selling price of the knives, the number of knives that will then be sold, and the project’s net present value (NPV). Which of the following best describes what type of analysis the manager is performing?A) scenario analysisB) sensitivity analysisC) break-even analysisD) EBIT-break even analysis A
Which of the following statements is FALSE?A) The break-even level of an input is the level for which the investment has an internal rate of return (IRR) of zero.B) The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital.C) When evaluating a capital budgeting project, financial managers should make the decision that maximizes net present value (NPV).D) Sensitivity analysis reveals those aspects of the project which are most critical when we are actually managing the project. A
Which of the following statements is FALSE?A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our net present value (NPV) analysis for the project.B) To compute the net present value (NPV) for a project, you need to estimate the incremental cash flows and choose a discount rate.C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty.D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input. D
Which of the following statements is FALSE?A) We can use scenario analysis to evaluate alternative pricing strategies for our project.B) Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters.C) The difference between the internal rate of return (IRR) of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision.D) Scenario analysis breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as each one of the underlying assumptions changes. D
The difference between scenario analysis and sensitivity analysis is ________.A) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis is based upon net present value (NPV)B) only sensitivity analysis allows us to change estimated inputs of net present value (NPV) analysisC) scenario analysis considers the effect on net present value (NPV) of changing multiple project parametersD) only scenario analysis breaks the net present value (NPV) calculation into its component assumptions C
An exploration of the effect of changing multiple project parameters on net present value (NPV) is called ________.A) scenario analysisB) internal rate of return (IRR) analysisC) accounting break-even analysisD) sensitivity analysis A
An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called ________.A) scenario analysisB) internal rate of return (IRR) analysisC) accounting break-even analysisD) sensitivity analysis D
Which of the following will cause the EBIT Break-Even for sales to increase?A) a decrease in the sales priceB) a decrease in depreciation expenseC) a decrease in selling, general, and administrative expensesD) a decrease in the number of units sold A
A real option is the obligation to take a particular business action. T/F False
Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?A) option to delayB) option to expandC) option to abandonD) option to switch A
After research into where to place a new restaurant, Burger Billies, a small fast-food chain, plans to open a new store near a small college. The anticipated customer base is students attending the college. They learn that a major fast food chain will be opening a franchise within the college, which leads the owners of Burger Billies to revise their estimate of sales to one below the break-even point. Which of the following is most likely the best real option for Burger Billies to take with regard to the proposed restaurant site?A) option to delayB) option to expandC) option to abandonD) option to switch C
A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?A) option to delayB) option to expandC) option to abandonD) option to switch B
Which of the following statements regarding real options is NOT correct?A) Real options should only be exercised when they increase the NPV of a project.B) Real options enhance the forecast of a project’s expected future cash flows by incorporating, at the start of the project, the effect of decisions that will be made at a later date. C) Real options give owners the right, but not the obligation, to exercise these opportunities at a later date.D) Real options build greater flexibility into a project and thus increase its net present value (NPV). B
Preference for cash today versus cash in the future in part determines net present value (NPV). T/F False
Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment. T/F True
Most corporations measure the value of a project in terms of which of the following?A) discount valueB) discount factorC) future value (FV)D) present value (PV) D
The present value (PV) of an investment is ________.A) the amount that an investment would yield if the benefit were realized todayB) the difference between the cost of the investment and the benefit of the investment in dollars todayC) the amount you need to invest at the current interest rate to re-create the cash flow from the investmentD) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate A
The Net Present Value rule implies that we should compare a project’s net present value (NPV) to zero. T/F True
Which of the following statements is FALSE?A) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.B) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.D) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive. D
The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity. T/F True
The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows. T/F False
Which of the following situations can lead to IRR giving a different decision than NPV?A) delayed investmentB) multiple IRRsC) differences in project scaleD) All of the above can lead to IRR giving a different decision than NPV D
According to Graham and Harvey’s 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________.A) NPV, IRR, MIRRB) MIRR, IRR, Payback periodC) IRR, NPV, Payback periodD) Profitability index, NPV, IRR C
Which of the following is NOT a limitation of the payback rule?A) It does not consider the time value of money.B) Lacks a decision criterion that is economically based.C) It is difficult to calculate.D) It does not consider cash flows occurring after the payback period C
Which of the following is NOT a valid method of modifying cash flows to produce a MIRR?A) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. B) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project.C) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project.D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project’s lifetime. D
Which of the following statements is FALSE?A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.B) An internal rate of return (IRR) will always exist for an investment opportunity.C) A net present value (NPV) will always exist for an investment opportunity.D) In general, there can be as many internal rates of return (IRRs) as the number of times the project’s cash flows change sign over time. B
Which of the following statements is FALSE?A) The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV).B) The payback rule is reliable because it considers the time value of money and depends on the cost of capital.C) For most investment opportunities, expenses occur initially and cash is received later.D) Fifty percent of firms surveyed reported using the payback rule for making decisions. B
When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule. T/F True
Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects. T/F False
When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns. T/F True
You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is ________.A) net present value (NPV)B) profitability indexC) internal rate of return (IRR)D) incremental internal rate of return (IRR) A
You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity. T/F True
When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment. T/F False
When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)?A) so that you can see which project has the greatest net present value (NPV)B) so that the projects can be compared on their cost or value created per yearC) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframeD) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered B
A lawn maintenance company compares two ride-on mowers—the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision?A) Fuel prices are expected to rise and raise the annual running costs of all mowers.B) The mower is only expected to be needed for three years.C) The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate.D) The number of customers requiring lawn-mowing services is expected to sharply increase in the near future. B
When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project. T/F False
The profitability index can break down completely when dealing with multiple resource restraints. T/F True
You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?A) internal rate of return (IRR)B) payback periodC) net present value (NPV)D) profitability index D
Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate. T/F True
When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed. T/F True
Which of the following best describes the Net Present Value rule?A) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.B) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV)C) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV).D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected. A
Which of the following is a disadvantage of the Net Present Value rule?A) can be misleading if inflows come before outflowsB) not necessarily consistent with maximizing shareholder wealthC) ignores cash flows after the cutoff pointD) relies on accurate estimate of the discount rate D
Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment?A) internal rate of return (IRR)B) profitability indexC) net present value (NPV)D) payback period D
Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity?A) profitability indexB) MIRRC) equivalent annual annuityD) payback period D
Which of the following is NOT a limitation of the payback period rule?A) It does not account for the time value of money.B) It is difficult to calculate.C) It ignores cash flows after payback.D) It does not account for changes in the discount rate. B
Which of the following is true regarding the profitability index?A) It does not use the net present value (NPV) to assess benefits.B) It is very simple to compute.C) Attention must be taken when using it to make sure that all of the constrained resource is utilized.D) It is unreliable when used for choosing between different projects. C
A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following?A) profitability indexB) payback periodC) net present value (NPV)D) internal rate of return (IRR) C

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