STUDY GUIDE
1. What is the beta of a firm whose equity has an expected return of 21.30%, the risk-free rate is 7%, and
the expected return on the stock market is 18%?
2. Two reasons for the agency problem in modern corporations is:
A. Dispersion of ownership,
B. Managers know how to manage the firm better than stockholders,
C. Separation of ownership and control of the firm,
D. [A] and [C].
3. Capital budgeting includes the evaluation of which of the following?
A. Size of future cash flows only
B. Size and timing of future cash flows
C. Timing and risk of future cash flows
D. Risk and size of future cash flows only
E. Size, timing, and risk of future cash flows
4. According to corporate finance, the financial manager is responsible for:
A. Capital budgeting,
B. The Financing decision,
C. Dividend policy,
D. All of the above.
5. The primary goal of a corporate finance manager is to maximize:
A. Current profits
B. Market share
C. Number of shares outstanding
D. Value of the firm
E. Revenue growth
6. Which of the following direct incentives may align management goals with shareholder interests?
I. Employee stock options
II. Threat of a takeover
III. Management bonuses tied to performance goals
IV. Threat of a proxy fight
A. I and III only
B. II and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV
7. The group of stakeholders of a firm includes:
A. Anyone with a direct or indirect interest in the firm as an ongoing business concern.
B. Anyone with control of the firm.
8. The net present value of any investment represents the difference between the investments:
A. cash inflows and outflows.
B. cost and its net profit.
C. cost and its market value.
D. cash flows and its profits.
E. assets and liabilities.
9. The payback period is the length of time it takes an investment to generate sufficient cash flows to
enable the project to:
A. produce a positive annual cash flow.
B. produce a positive cash flow from assets.
C. offset its fixed expenses.
D. offset its total expenses.
E. recoup its initial cost.
10. Which one of the following defines the internal rate of return for a project?
A. Discount rate that creates a zero cash flow from assets
B. Discount rate that results in a zero net present value for the project
C. Discount rate that results in a net present value equal to the project's initial cost
D. Rate of return required by the project's investors
E. The project's current market rate of return
11. Both Projects A and B are acceptable as independent projects. However, the selection of either one
of these projects eliminates the option of selecting the other project. Which one of the following terms
best describes the relationship between Project A and Project B?
A. Mutually exclusive
B. Conventional
C. Multiple choice
D. Dual return
E. Crosswise
12. Which one of the ...
STUDY GUIDE 1. What is the beta of a firm whose equity ha.docx
1. STUDY GUIDE
1. What is the beta of a firm whose equity has an expected
return of 21.30%, the risk-free rate is 7%, and
the expected return on the stock market is 18%?
2. Two reasons for the agency problem in modern corporations
is:
A. Dispersion of ownership,
B. Managers know how to manage the firm better than
stockholders,
C. Separation of ownership and control of the firm,
D. [A] and [C].
3. Capital budgeting includes the evaluation of which of the
following?
A. Size of future cash flows only
B. Size and timing of future cash flows
C. Timing and risk of future cash flows
D. Risk and size of future cash flows only
E. Size, timing, and risk of future cash flows
4. According to corporate finance, the financial manager is
responsible for:
2. A. Capital budgeting,
B. The Financing decision,
C. Dividend policy,
D. All of the above.
5. The primary goal of a corporate finance manager is to
maximize:
A. Current profits
B. Market share
C. Number of shares outstanding
D. Value of the firm
E. Revenue growth
6. Which of the following direct incentives may align
management goals with shareholder interests?
I. Employee stock options
II. Threat of a takeover
III. Management bonuses tied to performance goals
IV. Threat of a proxy fight
A. I and III only
B. II and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV
7. The group of stakeholders of a firm includes:
A. Anyone with a direct or indirect interest in the firm as an
ongoing business concern.
B. Anyone with control of the firm.
3. 8. The net present value of any investment represents the
difference between the investments:
A. cash inflows and outflows.
B. cost and its net profit.
C. cost and its market value.
D. cash flows and its profits.
E. assets and liabilities.
9. The payback period is the length of time it takes an
investment to generate sufficient cash flows to
enable the project to:
A. produce a positive annual cash flow.
B. produce a positive cash flow from assets.
C. offset its fixed expenses.
D. offset its total expenses.
E. recoup its initial cost.
10. Which one of the following defines the internal rate of
return for a project?
A. Discount rate that creates a zero cash flow from assets
B. Discount rate that results in a zero net present value for the
project
C. Discount rate that results in a net present value equal to the
project's initial cost
D. Rate of return required by the project's investors
E. The project's current market rate of return
11. Both Projects A and B are acceptable as independent
projects. However, the selection of either one
of these projects eliminates the option of selecting the other
project. Which one of the following terms
4. best describes the relationship between Project A and Project B?
A. Mutually exclusive
B. Conventional
C. Multiple choice
D. Dual return
E. Crosswise
12. Which one of the following indicates that a project is
expected to create value for its owners?
A. Profitability index less than 1.0
B. Payback period greater than the required period of time
C. Positive net present value
D. Positive average accounting rate of return
E. Internal rate of return that is less than the project’s
opportunity cost
13. The net present value:
A. decreases as the required or hurdle rate of return increases.
B. is equal to the initial investment when the internal rate of
return is equal to the required return.
C. method of analysis cannot be applied to mutually exclusive
projects.
D. is directly related to the discount rate.
E. is unaffected by the timing of an investment's cash flows.
14. If an investment is producing a return that is equal to the
required cost of capital, the project's net
present value will be:
A. positive.
B. greater than the project's initial investment.
C. zero.
D. equal to the project's net profit.
E. less than, or equal to, zero.
5. 15. If the initial investment of project X is -$400 million dollar,
the cash flow at the end of year 1 is +$
960 million and at the end of year 2 is $-572 million. Is the IRR
the right tool to make the investment
decision? (No need for calculations, just answer yes, no, or
maybe).
16. One implicit managerial incentive is:
A. The firm’s probability of bankruptcy,
B. Stock-options,
C. A bonus,
D. [B] and [C].
17. Which one of the following methods of analysis is most
appropriate to use when two investments
are mutually exclusive?
A. Internal rate of return
B. Profitability index
C. Net present value
D. Equivalent annuities
E. B and D
18. The net present value of project A is $442 with a maturity
of 5 years. The net present value of project
B is $478 with a maturity of 10 years. If the WACC is 12% and
both projects are mutually exclusive which
one you will pick?
6. 19. Any changes to a firm's projected future cash flows that are
caused by adding a new project are
referred to as which one of the following?
A. Eroded cash flows
B. Deviated projections
C. Incremental cash flows
D. Directly impacted flows
E. Assumed flows
20. Jamie is analyzing the estimated net present value of a
project under various what if scenarios. The
type of analysis that Jamie is doing is best described as:
A. sensitivity analysis.
B. erosion planning.
C. scenario analysis.
D. benefit planning.
E. opportunity evaluation
21. If financial markets are not efficient, then:
A. Expected returns are not needed,
B. The need for a discount rate to analyze project cash flows is
not needed,
C. Estimates of expected returns based on security prices are
not reliable,
D. None of the above.
22. Scenario analysis:
A. determines the impact a $1 change in sales has on the
7. internal rate of return.
B. determines which variable has the greatest impact on a
project's net present value.
C. helps determine the reasonable range of expectations for a
project's anticipated outcome.
D. evaluates a project's net present value while sensitivity
analysis evaluates a project's internal
rate of return.
E. determines the absolute worst and absolute best outcome
that could ever occur.
23. Turner Industries started a new project three months ago.
Sales arising from this project are
exceeding all expectations. Given this, which one of the
following is management most apt to
implement?
A. Option to wait
B. Soft rationing
C. Strategic option
D. Option to abandon
E. Option to expand
24. Ignoring the option to wait:
A. may overestimate the internal rate of return on a project.
B. may underestimate the net present value of a project.
C. ignores the ability of a manager to increase output after a
project has been implemented.
D. is the same as ignoring all strategic options.
E. ignores the value of discontinuing a project early.
25. The ability to delay an investment:
A. is commonly referred to as the best-case scenario.
B. is valuable provided there are conditions under which the
investment will have a positive net
present value in the future.
8. C. ensures that the investment will have an expected net
present value that is positive.
D. offsets the need to conduct sensitivity analysis.
E. is referred to as the option to abandon.
26. Explain the concept of incremental cash flow analysis and
its purpose.
27. Identify three managerial options that relate to project
analysis and explain how those options affect
the net present value of a project.
28. Which one of the following describes systemic risk?
A. Economic-driven risk that affects a large number of assets
B. An individual security's total risk
C. Diversifiable risk
D. Asset specific risk
E. Risk unique to a firm's management
29. Which of the following terms can be used to describe
unsystematic risk?
I. Asset-specific risk
II. Diversifiable risk
III. Market risk
IV. Unique risk
A. I and IV only
B. II and III only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, III, and IV
30. Which one of the following statistics measures the amount
of systematic risk present in a particular
9. risky asset relative to that in an average risky asset?
A. Squared deviation
B. Beta coefficient
C. Standard deviation
D. Mean
E. Variance
31. From the financial point of view the asset side of the
balance sheet of a corporation includes:
A. Fixed assets,
B. Growth assets,
C. Assets in place,
D. [B] and [C].
32. Which one of the following is the slope of the security
market line?
A. Risk-free rate
B. Market risk premium
C. Beta coefficient
D. Risk premium on an individual asset
E. Market rate of return
33. Which one of the following is the minimum required rate of
return on a new investment that makes
that investment attractive to any potential investor?
A. Risk-free rate
B. Market risk premium
C. Expected return minus the risk-free rate
D. Market rate of return
E. Cost of capital
10. 34. Which one of the following is the computation of the risk
premium for an individual security? E(R) is
the expected return on the security, Rf is the risk-free rate, β is
the security's beta, and E(RM) is the
expected rate of return on the market.
A. E(RM) - Rf
B. E(R) - E(RM)
C. E(R) - [E(RM) + Rf]
D. β[E(RM) - Rf]
E. β[E(R) - Rf]
35. Which one of the following is the best example of
unsystematic risk?
A. Inflation exceeding market expectations
B. A warehouse fire
C. Decrease in corporate tax rates
D. Decrease in the value of the dollar
E. Increase in private personal consumer spending
36. Which one of the following is the best example of
systematic risk?
A. Discovery of a major gas field
B. Decrease in textile imports
C. Increase in agricultural exports
D. Decrease in gross domestic product
E. Decrease in management bonuses for banking executives
37. Standard deviation measures _____ risk while beta measures
_____ risk.
A. systematic; unsystematic
B. unsystematic; systematic
C. total; unsystematic
D. total; systematic
11. E. asset-specific; market
38. Which one of the following portfolios will have a beta of
zero?
A. A portfolio that is equally as risky as the overall market
B. A portfolio that consists of a single stock
C. A portfolio comprised solely of U. S. Treasury bills
D. A portfolio with a zero variance of returns
E. No portfolio can have a beta of zero.
39. A risky security has less risk than the overall market. What
must the beta of this security be?
A. 0
B. > 0 but < 1
C. 1
D. > 1
E. The beta cannot be determined based on the information
provided.
40. The addition of a risky security to a fully diversified
portfolio:
A. must decrease the portfolio's expected return.
B. must increase the portfolio beta.
C. may or may not affect the portfolio beta.
D. will increase the unsystematic risk of the portfolio.
E. will have no effect on the portfolio beta or its expected
return.
41. Which one of the following is the vertical intercept of the
security market line?
A. Market rate of return
B. Individual security rate of return
C. Market risk premium
D. Individual security beta multiplied by the market risk
premium
E. Risk-free rate
12. 42. Based on the capital asset pricing model, investors are
compensated based on which of the
following?
I. Market risk premium
II. Portfolio standard deviation
III. Portfolio beta
IV. Risk-free rate
A. I and III only
B. II and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV
43. Ben & Terry's has an expected return of 12.9 percent and a
beta of 1.25. The expected return on the
market is 11.7 percent. What is the risk-free rate?
A. 3.87 percent
B. 4.24 percent
C. 4.61 percent
D. 6.29 percent
E. 6.92 percent
44. Under the narrow definition of corporate governance, the
financial manager is responsible for making
decisions that are in the best interest of the firm's owners.
A. True,
B. False
13. 45. The weighted average cost of capital is defined as the
weighted average of a firm's:
A. return on its investments.
B. cost of equity and its after-tax cost of debt.
C. pretax cost of debt and equity securities.
D. bond coupon rates.
E. dividend and capital gains yields.
46. Which of the following will increase the cost of equity for a
firm with a beta of 1.1?
I. Decrease in the security's beta
II. Decrease in the market risk premium
III. Decrease in the risk-free rate
IV. Increase in the risk-free rate
A. II only
B. III only
C. I and II only
D. II and III only
E. I and IV only
47. All else constant, which of the following will increase the
after-tax cost of debt for a firm?
I. Increase in the yield to maturity of the firm's outstanding debt
II. Decrease in the yield to maturity of the firm's outstanding
debt
III. Increase in the firm's tax rate
IV. Decrease in the firm's tax rate
A. I only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
14. 48. Which one of the following will affect the capital structure
weights used to compute a firm's
weighted average cost of capital?
A. Decrease in the book value of a firm's equity
B. Decrease in a firm's tax rate
C. Increase in the market value of the firm's common stock
D. Increase in the market risk premium
E. Increase in the firm's beta
49. A firm has a cost of equity of 13 percent, a cost of preferred
of 11 percent, and an after-tax cost of
debt of 6 percent. Given this, which one of the following will
increase the firm's weighted average cost
of capital?
A. Increasing the firm's tax rate
B. Issuing new bonds at par
C. Redeeming shares of common stock
D. Increasing the firm's beta
E. Increasing the debt-equity ratio
50. Bermuda Cruises issues only common stock and coupon
bonds. The firm has a debt-equity ratio of
0.65. The cost of equity is 18.3 percent and the pretax cost of
debt is 9.9 percent. What is the capital
structure weight of the firm's equity if the firm's tax rate is 34
percent?
A. 46.75 percent
B. 49.97 percent
C. 52.93 percent
D. 59.08 percent
E. 60.61 percent
51. M & M proposition I states that the capital structure
problem is irrelevant
A. True,
15. B. False.
52. The WACC of the firm is 13%. You know that the firm's
cost of debt is 10% and the cost of equity 20%.
What proportion of the firm is financed with debt?
53. Paying interest reduces the taxes owed by a firm. Which one
of the following terms applies to this
relationship?
A. Static theory of interest rates
B. M&M Proposition I
C. Financial risk
D. Interest tax shield
E. Homemade leverage
54. No separation in the capital markets:
A. Provides support to the pecking order theory of Myers and
Majluf,
B. Means that there is only one big global market,
C. Builds from Akerlof’s lemons problem,
D. [A] and [C].
55. Which one of the following is a direct bankruptcy cost?
A. Loss of customer goodwill resulting from a bankruptcy
filing
B. Legal and accounting fees related to a bankruptcy
proceeding
16. C. Management time spent on a bankruptcy proceeding
D. Any financial distress cost
E. Costs a firm spends trying to avoid bankruptcy
56. Given the lemons problem:
A. One can observe a market breakdown,
B. Information asymmetries are crucial to explain the
efficiency of the markets,
C. Cross-subsidization may happen,
D. All of the above.
57. Two determinants of the optimal debt ratio are:
A. Depreciation,
B. Operating risk,
C. Marginal tax rate,
D. [B] and [C].
58. Which one of the following statements is the core principle
of M&M Proposition I (without taxes)?
A. A firm's cost of equity is directly related to the firm's debt-
equity ratio.
B. A firm's WACC is directly related to the firm's debt-equity
ratio.
C. The interest tax shield increases the value of a firm.
D. The capital structure of a firm is totally irrelevant.
E. Levered firms have greater value than unlevered firms.
17. 59. Which one of the following is an implication of M&M
Proposition II (with taxes)?
A. A firm's optimal capital structure is 100 percent debt.
B. WACC is unaffected by the capital structure of a firm.
C. WACC decreases as the debt-equity ratio increases.
D. A firm's capital structure is irrelevant.
E. The risk of equity depends on financial leverage and the
riskiness of the firm's operations.
60. Which one of the following represents the present value of
the interest tax shield?
A. D × (1 - Tc)
B. D/(1 - Tc)
C. D/Tc
D. D - D(Tc)
E. Tc × D
61. Which one of the following factors favors a high-dividend
payout?
A. Low transaction costs on stock trades
B. Lower taxes on capital gains than on dividends
C. Tax deferment on capital gains, but not on dividend income
D. Flotation costs
E. Corporate shareholders
62. Cash dividends send which two of the following signals to
the market?
I. Agency costs will be lowered since less cash will be held by
the firm.
II. The firm is planning on downsizing.
III. The firm is currently, and expects to continue to be,
profitable.
18. IV. The firm will no longer conduct stock repurchases.
A. I and II only
B. II and III only
C. III and IV only
D. II and IV only
E. I and III only
63. The winners’ curse in IPOs refers to:
A. The negative price reaction after going public because of
overvaluation.
B. The negative price reaction after going public because of
colluding between the syndicate of
underwriters and the issuer.
64. The beta of the stock is 1.25, the marginal tax rate of the
firm is 36%, and the debt equity ratio is 0.30.
What is the value of the unlevered beta?
65. Explain briefly the pecking order theory of funds developed
by Myers and Majluf (1984)? What is Ross
(1977) argument for separation in the capital markets?