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26. The value of a proposed capital budgeting project depends upon the:
A. total cash flows produced.
B. incremental cash flows produced.
C. accounting profits produced.
D. increase in total sales produced.
27. The rationale for not including sunk costs in capital budgeting decisions is
that they:
A. are usually small in magnitude.
B. revert at the end of the investment.
C. have no incremental effect.
D. reduce the estimated NPV.
28. If a project's cash flows exceed the project's incremental cash flows, it is likely
that the:
A. project interacts with other aspects of the firm.
B. project must have high depreciation expense.
C. opportunity cost of capital must be high.
D. project will have a negative NPV.
29. When is it appropriate to include sunk costs in the evaluation of a project?
A. Include sunk costs when they are relatively large.
B. Include sunk costs if it improves the project's NPV.
C. Include sunk costs if they are considered to be overhead costs.
D. It is never appropriate to include sunk costs.
30. A cost should be considered sunk when it:
A. is fully depreciated.
B. produces no additional sales revenues.
C. has no effect on future flows.
D. is replaced by costs that are not yet sunk.
31. The opportunity cost of an asset:
A. should be depreciated annually.
B. can differ depending on market conditions.
C. is typically ignored in capital budgeting.
D. is important only for parcels of land.
Chapter 10
Chapter 11
33. Macro events only are reflected in the performance of the market portfolio
because:
A. the market portfolio has no individual firms.
B. only macro events are tracked by economists.
C. unique risks have been diversified away.
D. firm-specific events would be too numerous to list.
34. In practice, the market portfolio is often represented by:
A. a portfolio of U.S. Treasury securities.
B. a diversified stock market index.
C. an investor's mutual fund portfolio.
D. the historic record of stock market returns.
35. A stock's beta measures the:
A. average return on the stock.
B. variability in the stock's returns compared to that of the market portfolio.
C. difference between the return on the stock and return on the market portfolio.
D. market risk premium on the stock.
36. The sensitivity of a stock's returns to the returns on a market portfolio is
referred to as the:
A. stock's market risk premium.
B. stock's beta.
C. market portfolio's systematic risk.
D. stock's unique risk.
37. When the overall market is up by 10%, an investor with a portfolio of
defensive stocks will probably have:
A. negative portfolio returns less than 10%.
B. negative portfolio returns greater than 10%.
C. positive portfolio returns less than 10%.
D. positive portfolio returns greater than 10%.
38. When the overall market experiences a decline of 8%, an investor with a
portfolio of aggressive stocks will probably experience:
A. negative portfolio returns of less than 8%.
B. negative portfolio returns of greater than 8%.
C. positive portfolio returns of less than 8%.
D. positive portfolio returns of greater than 8%.
39. A stock with a beta greater than 1.0 would be termed:
A. an aggressive stock, expected to increase more than the market increases.
B. a defensive stock, expected to decrease more than the market increases.
C. an aggressive stock, expected to decrease more than the market increases.
D. a defensive stock, expected to increase more than the market decreases.
40. The average of beta values for all individual stocks is:
A. greater than 1.0; most stocks are aggressive.
B. less than 1.0; most stocks are defensive.
C. unknown; betas are continually changing.
D. exactly 1.0; these stocks represent the market.
41. The line plotted to fit observations of a stock's returns versus the market's
returns determines the:
A. security market line.
B. beta of the stock.
C. market risk premium.
D. capital asset pricing model.
42. If a stock consistently goes down (up) by 1.6% when the market portfolio
goes down (up) by 1.2% then its beta:
A. equals 1.04.
B. equals 1.24.
C. equals 1.33.
D. equals 1.40.
43. If the slope of the line measuring a stock's historic returns against the
market's historic returns is positive, then the stock:
A. has a beta greater than 1.0.
B. has no unique risk.
C. has a positive beta.
D. plots above the security market line.
Chapter 12
33. Macro events only are reflected in the performance of the market portfolio
because:
A. the market portfolio has no individual firms.
B. only macro events are tracked by economists.
C. unique risks have been diversified away.
D. firm-specific events would be too numerous to list.
34. In practice, the market portfolio is often represented by:
A. a portfolio of U.S. Treasury securities.
B. a diversified stock market index.
C. an investor's mutual fund portfolio.
D. the historic record of stock market returns.
35. A stock's beta measures the:
A. average return on the stock.
B. variability in the stock's returns compared to that of the market portfolio.
C. difference between the return on the stock and return on the market portfolio.
D. market risk premium on the stock.
36. The sensitivity of a stock's returns to the returns on a market portfolio is
referred to as the:
A. stock's market risk premium.
B. stock's beta.
C. market portfolio's systematic risk.
D. stock's unique risk.
37. When the overall market is up by 10%, an investor with a portfolio of
defensive stocks will probably have:
A. negative portfolio returns less than 10%.
B. negative portfolio returns greater than 10%.
C. positive portfolio returns less than 10%.
D. positive portfolio returns greater than 10%.
38. When the overall market experiences a decline of 8%, an investor with a
portfolio of aggressive stocks will probably experience:
A. negative portfolio returns of less than 8%.
B. negative portfolio returns of greater than 8%.
C. positive portfolio returns of less than 8%.
D. positive portfolio returns of greater than 8%.
39. A stock with a beta greater than 1.0 would be termed:
A. an aggressive stock, expected to increase more than the market increases.
B. a defensive stock, expected to decrease more than the market increases.
C. an aggressive stock, expected to decrease more than the market increases.
D. a defensive stock, expected to increase more than the market decreases.
40. The average of beta values for all individual stocks is:
A. greater than 1.0; most stocks are aggressive.
B. less than 1.0; most stocks are defensive.
C. unknown; betas are continually changing.
D. exactly 1.0; these stocks represent the market.
41. The line plotted to fit observations of a stock's returns versus the market's
returns determines the:
A. security market line.
B. beta of the stock.
C. market risk premium.
D. capital asset pricing model.
42. If a stock consistently goes down (up) by 1.6% when the market portfolio
goes down (up) by 1.2% then its beta:
A. equals 1.04.
B. equals 1.24.
C. equals 1.33.
D. equals 1.40.
43. If the slope of the line measuring a stock's historic returns against the
market's historic returns is positive, then the stock:
A. has a beta greater than 1.0.
B. has no unique risk.
C. has a positive beta.
D. plots above the security market line.
Chapter 13
31. Proposed assets can be evaluated using the company cost of capital
providing that the:
A. firm does not pay taxes.
B. firm is all equity financed.
C. cost of debt is less than the cost of equity.
D. new assets have the same risk as existing assets.
32. The company cost of capital for a firm with a 65/35 debt/equity split, 8% cost
of debt, 15% cost of equity, and a 35% tax rate would be:
A. 7.02%
B. 9.12%
C. 10.45%
D. 13.80%
0.65x 8% + 0.35 x 15% = 10.45%
33. The company cost of capital, after tax, for a firm with a 65/35 debt/equity
split, 8% cost of debt, 15% cost of equity, and a 35% tax rate would be:
A. 7.02%
B. 8.63%
C. 10.80%
D. 13.80%
35. What is the pretax cost of debt for a firm in the 35% tax bracket that has a
10% after-tax cost of debt?
A. 5.85%
B. 12.15%
C. 15.38%
D. 25.71%
after-tax cost of debt = pretax cost x (1 - tax rate)
10% = pretax cost x .65
15.38% = pretax cost of debt
36. How much is added to a firm's weighted average cost of capital for 45% debt
financing with a required rate of return of 10% and a tax rate of 35%?
A. 1.29%
B. 2.93%
C. 3.50%
D. 4.50%
43. How much will a firm need in cash flow before tax and interest to satisfy
debtholders and equityholders if: the tax rate is 35%, there is $13 million in
common stock requiring a 10% return, and $6 million in bonds requiring an 6%
return?
A. $1,392,000
B. $1,488,000
C. $2,360,000
D. $2,480,000
45. What will be the effect of using book value of debt in WACC decisions if
interest rates have decreased substantially since a firm's long-term bonds were
issued?
A. The debt-to-value ratio will be overstated.
B. The debt-to-value ratio will be understated.
C. There will be no effect on WACC decisions.
D. Cannot be determined without knowing interest rates.
Thus, the debt-to-value ratio is .286. However, if the market value of debt is $2.5
million due to increased interest rates, the value of the firm is $7.5 million and
the debt-to-value ratio is .333. The key is that the numerator of the ratio changes
proportionately more than the denominator.
46. Which component is more likely to be biased if book values are used in the
calculation of WACC rather than market values?
A. Debt
B. Preferred stock
C. Common stock
D. All categories should be equally biased.
47. What would you estimate to be the required rate of return for equity investors
if a stock sells for $40 and will pay a $4.40 dividend that is expected to grow at a
constant rate of 5%?
A. 7.6%
B. 12.0%
C. 12.6%
D. 16.0%
Chapter 16