final exam

Question 1

The dividend model for pricing common shares says that the market price of a common share can be viewed as the PV of its expected future dividend payouts.
True or False

Answer 1

True

Question 2

Assuming a 5-year investment horizon, the dividend model implies that the share price equals the PV of per-share dividend paid for the five years plus the PV of the share’s market price at the end of five years.
True or False

Answer 2

True

Question 3

The discount rate used to calculate the PV of expected future dividends equals the shareholders’ opportunity cost of equity capital (k).
True or False

Answer 3

True

Question 4

The shareholder’s opportunity cost of equity capital is also called the shareholders’ “required (or expected) rate of return, or equity capitalization rate”.
True or False

Answer 4

True

Question 5

Is it true that if per-share dividend is expected to grow steadily at rate g then we can calculate the share price (P.) by the Gordon Valuation Formula given below?
Po = D1 / ke-8 , where we are given ke, g and D1, (the per-share dividend expected at the end of the current period i.e. at the end of one-period from to-day). If D1 is not given but Do (the per-share dividend just before the start of the current period), and g are given, then we can calculate D1 = Do (1+g).

Answer 5

True

Question 6

Is it true that if we are given Po, D1 and g, we can calculate the shareholders’ required rate of return (ke) as follows?
ke = D1/Po + g
= dividend yield + per-share dividend growth rate

Answer 6

True

Question 7

Is it true that the per-share dividend growth rate g can be interpreted as the capital gain (loss) rele (I.e. rale of price appreciation, or decline ?
True or False

Answer 7

True

Question 8

Shareholders of a non-dividend paying company expect to earn ke entirely through the capital gain rate.
True or False

Answer 8

True

Question 9

Two companies may provide the same ke but different dividend yields.
True or False

Answer 9

True

Question 10

Given that capital gains are taxed at a lower rate than dividend income, shares of companies that pay no dividends or low per-share dividend are more attractive to investors from the viewpoint of taxes.
True or False

Answer 10

True

Question 11

For a company that pays out all its earnings as dividends (i.e. retains no earnings for investment in new assets to generate growth in future earnings and dividends), g=0 and ke=D1/Po = E/Po, where E denotes the earnings per share.
True or False

Answer 11

True

Question 12

The fraction of earnings retained for investment in new assets to generate growth is called the “Retention Ratio” or “Plowback Ratio”
True or False

Answer 12

True

Question 13

Retention Ratio = (1 - dividend payout ratio)
True or False

Answer 13

True

Question 14

Is it true that the per share dividend growth rate g can be estimated in two ways: by extrapolating (i.e. forecasting from) the per share dividends paid in the past several periods or by using the formula: g= Plowback or Retention Ratio x ROA where ROA stands for “Return on Assets”
True or False

Answer 14

True

Question 15

The price-earnings or P/E ratio (also called the P/E multiple) is generally thought to reflect the future growth expectations of investors (concerning assets, earnings and dividends)
True or False

Answer 15

True

Question 16

Interest rate changes affect stock prices
True or False

Answer 16

True

Question 17

Shareholders’ required rate of return ke can be viewed as the firm’s cost of outstanding common share capital (i.e. equity capital)
True or False

Answer 17

True

Question 18

A preferred share has features of both debt and common shares
True or False

Answer 18

True

Question 19

Is it true that if we are given the preferred shareholders’ opportunity cost of capital (kp), and the preferred dividend per share (Dp), we can calculate the market price Po of a preferred share as follows?
Po = Dp / kp

Answer 19

True

Question 20

Is it true that if we are given Dp, and Po, we can calculate kp as follows?
kp = Dp/Po

Answer 20

True

Question 21

kp is also called the preferred shareholders’ required (or expected) rate of return
True or False

Answer 21

True

Question 22

Preferred shareholders’ required rate of return kp can be viewed as the firm’s cost of outstanding preferred share capital
True or False

Answer 22

True

Question 23

A firm’s cost of capital is the minimum ale ol return that the firm must cam on its investments in order to pay the rates of retur
reg vireo by all Is capilal suppliers, commensurate with the risks they assure.
True or False

Answer 23

True

Question 24

Under two assumptions, the cost of capital can be measured as a weighted average of costs of the different types of capital it uses (equity, long-term debt and preferred shares)
True or False

Answer 24

True

Question 25

The first assumption is that the new investments (projects) do not change the business risk of the firm; that is, the new projects are the average risk projects. True or False

Answer 25

True

Question 26

The second assumption is that the firm maintains a target capital structure (i.e. B/V, E/V and PS/V ratios) and new projects, on average, are financed with the target capital structure proportions True or False

Answer 26

True

Question 27

The above assumption is referred to as “pool of funds approach” True or False

Answer 27

True

Question 28

Under the pool of funds approach, if an average risk project is financed entirely with debt at, say, 8% after-tax cost of debt but the WACC is, say, 11%, then for the project to be acceptable, the minimum rate of the return must be 11%, not 8% True or False

Answer 28

True

Question 29

An average-risk project. will lower the market value of the firm and its common shares if it eams a rate of retum less than the WACC True or False

Answer 29

True

Question 30

The WACC is often called the cost of capital and is used as the discount rate to calculate the NPV's of average-risk project. True or False

Answer 30

True

Question 31

In order for an above-average-risk project to be acceptable, it must earn a rate of return greater than the WACC. True or False

Answer 31

True

Question 32

A below-average-risk project may be acceptable even if its rate of return is less than the WACC. True or False

Answer 32

True

Question 33

While the cost of debt needs tax adjusument, the costs of preferred shares and common share equity do not. True or False

Answer 33

True

Question 34

The costs of outstanding (existing) debt, preferred shares, and common share equity are their respective opportunity costs expressed as percentages. True or False

Answer 34

True

Question 35

The costs of new debt, preferred shares, and common shares, are higher than those of outstanding debt, preferred shares and common share equity because they reflect after-tax underwriting and issuing costs True or False

Answer 35

True

Question 36

The cost of common equity obtained through retained earnings equals the cost of outstanding common share equity True or False

Answer 36

True

Question 37

The cost of retained earings is an opportunity cost. True or False

Answer 37

True

Question 38

When a firm uses equity capital from both retained earnings and new common shares, the marginal cost principle says that relatively higher cost of new common share equily be used in the WACC calculation. True or False

Answer 38

True

Question 39

The cost ol capital obtained through the use of depreciation is an opportunity cost equal to the WACC. True or False

Answer 39

True

Question 40

The cost of depreciation need not be included in the WACC calculation True or False

Answer 40

True

Question 41

It is theoretically correct to calculate the WACC with market-value-based capital structure proportions (weights), but book-value weights are also used. True or False

Answer 41

True

Question 42

The cost of outstanding common equity can be calculated either by the Gordon formula of Session 5 or by the CAPM (SML). True or False

Answer 42

True

Question 43

In both the cases in Question 20 above, the cost of new common equity equals the cost of outstanding common equity multiplied by Pe/NPe, where Pe, is the market price per share and NPe is the net proceeds per share. True or False

Answer 43

True

Question 44

Cash invested for a short-erm of one year or less (e.g, in bank certificates of deposit, and in govemment treasury bills, traded in the "money market"') is called "money" but the cash invested for a long-term (e.g. in long-lerm financial assets such as bonds, and common stocks, in "capital market" or in any long-lerm real assets such as land and factories) is called "capital". True or False

Answer 44

True

Question 45

Funds invested in physical assets such as plants and equipment or in R&D, all of which produce long-ferm future benefits (income) beyond one year, is called "capital expenditure" or "capital outlay". True or False

Answer 45

True

Question 46

Capital expenditures" are distinct from "operating expenses" incured to operate day. to.dav in business. True or False

Answer 46

True

Question 47

The term "capital budget" does not imply a limited sum set aside for capital expenditure True or False

Answer 47

True

Question 48

A firm's capital budget is as large as the total capital outlay required for all economically profitable projects (i.e. all positive NPV projects). True or False

Answer 48

True

Question 49

The term capital budgeting means the process of screening and selection of investment projects or proposals that require capital outlays True or False

Answer 49

True

Question 50

When a firm imposes a ceiling on total expenditures to be incurred (no matter every positive NPV project is undertaken or not), it is said to operate under "capital rationing” True or False

Answer 50

True

Question 51

When a firm operates under capital rationing, some positive NPV projects may not be taken because of the budget constraint or ceiling. True or False

Answer 51

True

Question 52

The statement in Question 8 implies that some projects whose IRR exceeds the cost of capital outlay needed for the project may not be taken. True or False

Answer 52

True

Question 53

There are two categories of capital investment decisions: "Accept-Reject (yes-no) decisions” and “ranking decisions". True or False

Answer 53

True

Question 54

Ranking decisions are necessary when the projects are "mutually exclusive" (i.e. the acceptance of one implies the rejection of others); or when the firm operates under capital rationing, where capital is rationed (allocated) to only that group of positive NPV projects that provide maximum total NPV, and some positive NPV projects are left out because of the capital constraint or ceiling. True or False

Answer 54

True

Question 55

An accept-reject (yes-no) decision on any particular proposal, from among available proposals, can be made independently of the other proposals only if that proposal is economically independent of the other proposals. True or False

Answer 55

True

Question 56

An investment proposal is said to be "economically independent" of another proposal if its operating cashflows and the likelihood of its acceptance are not affected by the acceptance or rejection of the other proposal. True or False

Answer 56

True

Question 57

Investment proposals that are not economically independent are said to be "economically dependent". True or False

Answer 57

True

Question 58

Economically dependent investment proposals must be grouped together as one project. True or False

Answer 58

True

Question 59

Economic dependencies can occur through interdependence of sales revenues or through interdependencies of operating costs. True or False

Answer 59

True

Question 60

Economic dependencies among investment proposals must be considered when evaluating a set of proposals. True or False

Answer 60

True

Question 61

Investment proposals are said to be statistically dependent if their operating cashflows are correlated because they are affected by an underlying factor (such as business cycles) in the economy. True or False

Answer 61

True

Question 62

Statistical dependence may or may not imply a "cause-effect” relationship, whereas economic dependence does. True or False

Answer 62

True

Question 63

Economic evaluation of a project calls for estimates of future incremental after-tax net operating cashflows, which are simply referred to as "net cashflows " or "cash inflows" or simply "cashflows" True or False

Answer 63

True

Question 64

Only the operating revenues and operating expenses or costs are included in the cashflows described in Question 20 above. Financing expenses or costs such as interest expenses or dividend payouts are not included True or False

Answer 64

True

Question 65

Financing expenses are reflected in the "cost of capital" used as a discount rate in the discounted cashflow (DCF) criteria such as NPV, PI or IRR. True or False

Answer 65

True

Question 66

The principle of estimating "incremental" cashflows implies that the market value (net of tax effects, if any) of any existing assets or resources used in the project must be considered as an indirect (or opportunity) cost of taking the project. True or False

Answer 66

True

Question 67

The "sunk costs" (that is, the costs or expenses already incurred before a decision on a project is to be made) should not be considered in the proiect evaluation. True or False

Answer 67

True

Question 68

In comparing mutually exclusive alternatives, benefits or costs that are common to both should be ignored. True or False

Answer 68

True

Question 69

A useful framework for a systematic estimation of cashflows associated with a project calls for a breakdown of all periodic operating expenses and benefits into the following three major categories: Initial cashflows (after taxes, if any) Operating cashflows (after taxes) Terminal cashflows (after taxes, if any) True or False

Answer 69

True

Question 70

Aggregated amount of all after-tax initial cashflows (including both direct and indirect costs) is called the "initial investment". True or False

Answer 70

True

Question 71

Any changes in the working capital accounts, as a consequence of initiating a project, must be aggregated as changes in the “net working capital”, and included as part of the firm’s initial investment True or False

Answer 71

True

Question 72

It is generally assumed that the entire net working capital included in the initial investment is recovered at the termination of the project. True or False

Answer 72

True

Question 73

The future incremental after-tax net operating cashflows (abbreviated as 🔺CFAT), for any future year, equals: (1-t) (🔺R-🔺C) + t🔺CCA where 🔺R = incremental cash revenue, 🔺C = incremental cash operating costs or expenses, and t.🔺CCA is tax savings from incremental CCA available at the year-end. True or False

Answer 73

True

Question 74

A project's terminal cashflow occurs when the project's useful or economic life terminates True or False

Answer 74

True

Question 75

Terminal cashflows often arise from tax-adjusted salvage or residual value of physical assets and from the recovery of net working capital that was included in the project's initial cashflows. True or False

Answer 75

True

Question 76

There Are two types of criteria used in the evaluation and ranking of capital investment projects: the non-DCF criteria (such as the Payback Penod and the Accounting Rate of Return), which do not reflect k (the cost of capital invested in the projects) and the DCF criteria (such as the NPV, PI, and IRR) that do reflect k. True or False

Answer 76

True

Question 77

The Payback period is the number of periods (years) it would take to recover the initial investment in the project True or False

Answer 77

True

Question 78

The Payback criterion ignores the cost of financing (I.e the cost of capital) and the "target payback period" is set arbitrarily. True or False

Answer 78

True

Question 79

The Payback criterion is also myopic in that it ignores cashflows beyond the payback period . True or False

Answer 79

True

Question 80

The Accounting Rate of Return (AROR) from a project for any given year is simply the net income for that year divided by the average book value of assets used in the project in that year True on False

Answer 80

True

Question 81

AROR varies from year-to-year because of the diminishing book value of assets due te depreciation; and as such it depends on the depreciation method used for reporting purposes True or False

Answer 81

True

Question 82

The IRR (the internal rate of return, also called the "rate of return" or the "yield) is that discount rate at which the PV of future cashflows equals the initial investment i.e. PV = I or PV-I = NPV = 0 True or False

Answer 82

True

Question 83

Alternatively. we can define the IRR as the discount rate at which NPV=0 True or False

Answer 83

True

Question 84

A project is accepted if NPV is positive, resected if NPV is negative True or False

Answer 84

True

Question 85

NPV = 0 means that the IRR of the project just equals k (the cost of capital). Hence, a zero NPV project has no economic impact on the firm True or False

Answer 85

True

Question 86

Positive NPV (IRR > k) implies that in an informationally efficient capital market, the market value of the firm and its common shares will go up by an amount equal to the NPV: and the opposite will happen if NPV Is negative (IRR

Answer 86

True

Question 87

Net present value is net of the initial investsent, operating expenses, taxes, and the cost of financing (or capital) reflected in k through the discounting process. True or False

Answer 87

True

Question 88

NPV increases as k decreases: and it decreases as k increases True or False

Answer 88

True

Question 89

When NPV = 0, IRR = k. True or False

Answer 89

True

Question 90

B/C Ratio or PI = PV/1. Because PV-I = NPV, we can write PV = I+NPV and, therefore, PI= (I + NPV)/I = One + NPV/I True or False

Answer 90

True

Question 91

From Pl = One +NPV/I , it is clear that PI > 1 when NPV > 0; and Pl < I when NPV <0; and PI = One when NPV = 0. True or False

Answer 91

True

Question 92

The PI criterion says: Accept the project if its Pl > I; reject if PI <1. True or False

Answer 92

True

Question 93

In Accept-Reject (yes-no) decisions, all the three DCF criteria (NPV, PI, and IRR) give identical decisions. True or False

Answer 93

True

Question 94

NPV and IRR project rankings can be in conflict; also NPV and PI rankings can be in conflict True or False

Answer 94

True

Question 95

NPV and IRR rankings of projects can be in conflict in three possible situations: (i) when the initial investments for the projects differ significantly; (ii) when the economic lives of the projects differ significantly, and (iii) when the future cashflow patterns of the projects significantly. True or False

Answer 95

True

Question 96

The reason for conflicting NPV and IRR rankings is the different assumptions of the two criteria with respect to the reinvestment of the project’s future cashflows: the NPV criterion assumes that the future cashflows would be invested at a rate of return equal to the project's cost of capital; the IRR criterion assumes that they would be invested at a rate of return equal to the IRR itself. True or False

Answer 96

True

Question 97

The conflicting NPV and IRR rankings can be made identical by using " Incremental analysis” True or False

Answer 97

True

Question 98

The NPV profile of a project is a graphical representation of how the project's NPV changes as the project’s cost of capital (used as a discount rate) changes. True or False

Answer 98

True

Question 99

The point of intersection of the NPV profiles of two projects (with conflicting NPV and IRR rankings) is called the "Fisher's Rate of Return" (FROR). True or False

Answer 99

True

Question 100

The significance of FROR is that at any cost of capital or discount rate below the FROR (to the left of FROR on the NPV profiles graph), the NPV and IRR rankings would be in conflict; and at any cost of capital or discount rate above the FROR (to the right of FROR on the NPV profiles graph), the NPV and IRR rankings would be identical. True or False

Answer 100

True

Question 101

The point of intersection (FROR) of the NPV profiles of two projects A and B represents the IRR of the incremental project (A-B), assuming A requires a larger initial investment True or False

Answer 101

True

Question 102

The NPV criterion is theoretically superior to the IRR criterion in that the NPV is calculated using the market-determined cost of capital. True or False

Answer 102

True

Question 103

Which of the following should not be treated as part of the cashflows when deciding whether or not to go ahead with a project on the production of a new car model? a. The expected reduction in the sales of the company's existing models due to the introduction of the new model. b. The expenditure on new plant and equipment for the project. c. The existing piece of machinery that will be used in the project and has a positive market value. d. The cost of survey conducted to assess the demand for the new model before deciding whether or not to go ahead with the project

Answer 103

d. The cost of survey conducted to assess the demand for the new model before deciding whether or not to go ahead with the project

Question 104

A project has a positive NPV at a discount rate of 109. Is the project's IRR greater or smaller than 10%?

Answer 104

Greater

Question 105

A project has a negative NPV at a discount rale of 14%. Is the project's IRR greater than or smaller than 14%?

Answer 105

Smaller

Question 106

A project's IRR just equals its cost of capital. What can you say about the project's NPV?A project's IRR just equals its cost of capital. What can you say about the project's NPV?

Answer 106

NPV = 0

Question 107

A project's IRR is greater than its cost of capital. Is the project's NPV positive or negative?

Answer 107

NPV is positive

Question 108

A project's IRR is smaller than its cost of capital. Is the project's NPV positive or negative?

Answer 108

NPV is negative

Question 109

A project's NPV = 0 at a discount rate of 10%. What is the project's IRR?

Answer 109

IRR = 10%