Finance Flashcards

Finance Mterm Quiz

1. The present value of an investment’s future cash flows divided by its initial cost is the: A. Net present value.B. Internal rate of return.C. Average accounting return.D. Profitability index.E. Payback period. D. Profitability index.
2. The principle that an investment should be accepted if the difference between the investment’s market value and its cost is positive and rejected if the difference is negative is referred to as the: A. Average accounting return rule.B. Internal rate of return rule.C. Profitability index rule.D. Discounted payback rule.E. Net present value rule. E. Net present value rule.
3. 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. E. Only the initial cash flow is negative.
4. The length of time needed to recover the initial investment once time value of money is considered is called the: A. Discounted payback period.B. Average accounting return period.C. Discounted net present value period.D. Payback period.E. Internal time interval. A. Discounted payback period.
5. Ranking conflicts can arise if one relies on IRR instead of NPV when: A. The first cash flow is negative and the remaining cash flows are positive.B. Projects are independent of one another.C. A project has more than one NPV.D. Projects are mutually exclusive.E. The profitability index is greater than one. C. A project has more than one NPV.
6. Generally, the most difficult part of utilizing the net present value concept is: A. Determining the initial cash outflow required to start a project.B. Computing the net present value once the discount rate and cash flows are determined.C. Determining whether the discount rate used is higher or lower than the internal rate of return.D. Estimating the future cash flows given the initial investment in the project.E. Making the accept/reject decision once the net present value is computed D. Estimating the future cash flows given the initial investment in the project.
7. The hypothesis that market prices reflect all publicly-available information is called efficiency in the: A. Open form.B. Strong form.C. Semi-strong form.D. Weak form.E. Stable form. C. Semi-strong form.
8. The hypothesis that market prices reflect all historical price information is called efficiency in the: A. Open form.B. Strong form.C. Semi-strong form.D. Weak form.E. Stable form. D. Weak form.
9. Over the past 50 years, which of the following investments has been considered the most risky? A. Canadian common stocksB. U.S. common stocksC. Treasury billsD. Long bondsE. Canadian small stocks E. Canadian small stocks
10. Which of the following is true about risk and return? A. Riskier assets will, on average, earn lower returns.B. The reward for bearing risk is known as the standard deviation.C. Based on historical data, there is no reward for bearing risk.D. An increase in the risk of an investment will result in a decreased risk premium.E. In general, the higher the risk the higher the expected return E. In general, the higher the risk the higher the expected return
How is the modified internal rate of return different from the IRR? When would it be preferred to the IRR? (4 points) The IRR modifies interim cash flows that are reinvested back into the project. It assumes that they are reinvested at a pre-specified rate, such as the normal return or even the risk free rate. The IRR rule implicitly assumes that all interim cash flows are reinvested at the internal rate of return. This is OK for projects with (1) conventional cash flows (where the only negative cash flow is the initial investment) and (23) in cases where the IRR is somewhat near the discount rate and not far away from the return on other company projects.
x yr1 8% yr2 21 yr3 17 yr4 -16 yr5 9 Calculate Arithmetic avg return(equal to mean), variance, and standard deviation for x and y. (.08+.21+.17+-.16+.09)/5=7.8% x(x-μ )²(.08-.078)²=.000004(.21-.078)²=.017424(.17-.078)²=.008464(-.16-.078)²=.056644(.09-.078)²=.000144 =.08272 Var.=.08272/(5-1)=.02068 Std Dev.=√.02068=14.38%
Calculating Returns and VaribilityYou’ve observed the following returns on Regina Comp’s stock over the past five yrs: 7%, -12%,11%, 38%, and 14%a) What is the arithmetic Avg over 5yrs?b)What is the variance of Returns over 5yrs?Std, Dev? (.07-.12+.11+.38+.14)/5=11.6%=Arithmetic((.07-.116)²+(-.12-.116)²+(.11-.116)²+(.38-.116)²+(.14-.116)²)/(5-1) = ό²=.127688ό=√.127688=.3373=33.73%
Calculating Portfolio BetasYou own a portfolio equally invested in a risk free asset and two stocks. If one of the stocks has a beta of 1.27 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio? The beta of a portfolio is the sum of the weight of each asset times the beta of each asset. If the portfolio is as risky as the market it must have the same beta as the market. Since the beta of the market is one, we know the beta of our portfolio is one. We also need to remember that the beta of the risk-free asset is zero. It has to be zero since the asset has no risk. Setting up the equation for the beta of our portfolio, we get:βp = 1.0 = 1/3(0) + 1/3(1.27) + 1/3(βX)1/3βp=1-1/3(1.27)βp=1.73
Using CAPM – A stock has a beta of 1.05, the expected return on the market is 10%, and the risk free rate is 3.8%. What must be the expected return on this stock be? CAPM states the relationship between the risk of an asset and its expected return. CAPM is: E(Ri)=Rf +[E(RM)-Rf]×βiSubstituting the values we are given, we find:E(Ri) = .038 + (.10 – .038)(1.05) = .1031 or 10.31%
Using CAPM- A stock has an expected return of 10.2%, the risk free rate is 4.5%, and the market risk premium is 7.5%. What must the beta of this stock be? We are given the values for the CAPM except for the β of the stock. We need to substitute these values into the CAPM, and solve for the β of the stock. One important thing we need to realize is that we are given the market risk premium. The market risk premium is the expected return of the market minus the risk-free rate. We must be careful not to use this value as the expected return of the market. Using the CAPM, we find:E(Ri) = .102 = .045+ .075βiβi(.075)=.102- .045βi=.76
Calculating Expected Return SS. of Econ. Prob of S. of Econ Portfolio if s. occursRecession .30 -.14Boom .70 .22 The expected return of an asset is the sum of the probability of each return occurring times the probability of that return occurring. So, the expected return of the asset is:E(R) = .3(-.14) + .7(.22) = .112 or 11.2%
Taxes and WACC IS Co. has a target debt-equity ratio of .45. It’s cost of equity is 13% and its cost of debt is 6%. If the Tax rate is 35%, what is the companies WACC? Here we need to use the debt-equity ratio to calculate the WACC. Doing so, we find: WACC = (1/1.45)x.13 + .06(.45/1.45)(1 – .35) = .101 or 10.1%
Calculating cost of Preferred Stock- Bank has an issue of preferred stock with a $4.25 stated dividend that just sold for $92 per share. What is the banks cost of preferred stock? The cost of preferred stock is the dividend payment divided by the price, so:RP = $4.24/$92 = 4.6%
Question 15) sheet a.He should look at the weighted average flotation cost, not just the debt cost.b. The weighted average floatation cost is the weighted average of the floatation costs for debt and equity, so:fT= We x Fe+Wd x FdfT = .08(.1/1.6) + .05(.6/1.6) = 6.9%c. The total cost of the equipment including floatation costs is:Amount raised(1 – .0658) = $15,000,000Amount raised = $15,000,000/(1 – .0658) = $16,056,338Even if the specific funds are actually being raised completely from debt, the flotation costs, and hence true investment cost, should be valued as if the firm’s target capital structure is used.

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