Module 4

Question 1

the number of years needed to recover the initial cash outlay of a capital budgeting project

Answer 1

Payback Period

Question 2

If the payback period is SHORTER than the firms guidelines for pay back, do you accept or reject

Answer 2

Accept

Question 3

selection of projects with the highest ________ will maximize the increase in shareholder wealth, the goal of the firm

Answer 3

Net Present Value (NPV)

Question 4

equal to the present value of all future cash flows less the investments initial outlay
If positive accept
If negative reject

Answer 4

Net Present Value

Question 5

Considered to be the most theoretically correct criterion for evaluating capital budgeting projects

Answer 5

Net Present Value

Question 6

the ratio of the present value of the future cash flows to the initial outlay
Same acceptance/rejection decision as NPV

Answer 6

Profitability Index (PI)

Question 7

present value of the future cash flows to the initial outlay

Gives the same accept/reject decision as NPV

Answer 7

Profitability Index (PI)

Question 8

helpful in ranking various projects because it lets investors quantify the value created per each investment unit. 1.0 is logically the lowest acceptable measure on the index, as any value lower than that number would indicate that the project’s present value (PV) is less than the initial investment.

Answer 8

Profitability Index

Question 9

Based solely on the estimated cash flows and is INDEPENDENT of required rate of return or other interest rates

Answer 9

Internal Rate of Return (IRR)

Question 10

the rate that makes the present value of future cash flows equal to the initial cost of their investment.

Answer 10

Internal Rate of Return (IRR)

Question 11

Underlying assumption of ________ is that the projects cash flows are reinvested at the projects _________

Answer 11

Internal Rate of Return (IRR)

Question 12

cost of capital and _____________ are the same

Answer 12

Internal Rate of Return (IRR)

Question 13

NPV=0, IRR=Required rate of return, then the PV of future cash flows exactly equals the initial outlay. PI also equals 1

Answer 13

Relationship between IRR, NPV, and PI

Question 14

________ has a flaw, there is potential for multiple internal rates of return if the cashflows are not normal

Answer 14

Internal Rate of Return

Question 15

The discount rate which causes the PV of a projects terminal value to equal the PV of costs. Found by compounding inflows at the cost of capital (RRR) assumes cashflows are reinvested at the RRR

Answer 15

MIRR

Question 16

Cash Flows are compressed (earned earlier than expected, the NPV increases (improves) as to all other analysis metrics (same with increase in cash flows)

If a projects salvage value or other cash flows increase that increases expected cash flows making the projects NPV and other metrics more favorable

If the same cash flows are expected to be earned over a longer time period, NPV will decline.

If the salvage value or other cash flows decrease NPV will decline

Answer 16

how cash flow amounts timing changes affect NPV IRR PI & payback would all change

Question 17

If the Required Rate of Return increases, the present value of future cash flows will ________ and NPV and PI will _________

Answer 17

decrease

decrease

Question 18

refers to the potential variability in future cash flows
the wider rage of possible future events that can occur the greater the risk
returns on common stock are _______ than returns from investing in a bank savings account

Answer 18

Risk

Question 19

The ______ the holding period, the less volatility in returns- especially for common stocks.

Answer 19

longer

volatility

Question 20

in a one year holding period, ______ are risky compared to _______.

Answer 20

Stocks

Bonds

Question 21

Over a one year holding period, _______ are risky compared to ______ and TBills, but over a __________ period, stocks become _________ risky compared to other investments.

Answer 21

stocks
bonds
longer
less

Question 22

a measure of how much the individual returns on the stock move with the overall market price “market risk”

Answer 22

beta

Question 23

a measure of how much the individual returns on the stock deviate from the expected value or the mean

Answer 23

standard deviation

Question 24

the weighted average of the POSSIBLE cash flows outcomes such as that the weights are the probabilities of the occurrence of the carious states of the economy

Answer 24

Expected Cash Flow

Question 25

group of investments held together, strive for diversification, characterized by included investments & the amount invested in each security

Answer 25

Portfolio concept

Question 26

the release of information not previously available , they have 2 parts the expected part and the surprise part

Answer 26

announcements

Question 27

discounted information to estimate the expected return, the surprise news influences the unexpected return

Answer 27

parts of company news and announcements

Question 28

theory states that share prices reflect all information. stocks trade at their fair market value on exchanges. investors benefit from investing in a low-cost, passive portfolio. Opponents of this theory believe that it is possible to beat the market and that stocks can deviate from their fair market values.

Answer 28

Efficient Market Hypothesis

Question 29

IF 2 stocks are perfectly _________ correlated diversification has ___________ on risk

Answer 29

Positively | no effect

Question 30

IF 2 stocks are perfectly _____________ correlated the portfolio is perfectly diversified

Answer 30

Negatively

Question 31

measures how closely the returns on two different stocks align

Answer 31

Correlation between assets

Question 32

if Beta is ________ the stock is expected to move in the same direction as the market

Answer 32

positive

Question 33

if Beta is __________ the stock is expected to decline in value if the market goes up and have a positive return if the market goes down

Answer 33

negative

Question 34

the statistical measure of market volatility, measuring how widely prices are dispersed from the average price. If prices trade in a narrow trading range, the return is a low value that indicates low volatility. If prices swing wildly up and down, returns are a high value that indicates high volatility.

Answer 34

Standard Deviation

Question 35

the point with __________ is that over time the unexpected increases and decreases in stock price over the short term due to "unexpected news" cancel out in the long term

Answer 35

Unexpected returns

Question 36

when positive it adds value to the frim

Answer 36

NPV

Question 37

the amount of change a proposed project will have on the value of the frim

Answer 37

NPV

Question 38

equal to zero, that means that the present value of future cash flows (discounted at the appropriate cost of capital) is exactly equal to the initial outflows (initial outlay). This also means that the discount rate is exactly equal to the project's IRR or internal rate of return.

Answer 38

When NPV is equal to ZERO

Question 39

generally considered to be the "gold standard" for capital budgeting analysis, which, by definition, is for long term projects.

Answer 39

NPV

Question 40

gives us the amount by which firm value changes

Answer 40

NPV

Question 41

gives no indication of the change in firm value.

Answer 41

IRR

Question 42

simplicity and it provides additional information to firms about fund availability for reinvestment. Managers may rely on it more for short term and/or lower initial outlay projects

Answer 42

Payback Period

Question 43

two key drawbacks to the use of the ___________, the time value of money is ignored and all cash flows after are ignored.

Answer 43

Negatives of using the payback period

Question 44

near term cash flows will result in higher or lower NPV and IRR (all else equal)

Answer 44

Higher

Question 45

The ________ the period until receipt of cash flows, the lower the NPV and the IRR

Answer 45

Longer

Question 46

what would happen to the NPV if the initial investment in fixed assets increased?

Answer 46

NPV would decrease

Question 47

what would happen to NPV if we had a higher salvage value at the end of the project?

Answer 47

It would increase

Question 48

If the IRR= the RRR "discount rate" for the project, the NPV will be

Answer 48

ZERO- this is the relationship between NPV and IRR

Question 49

If the NPV is positive, the project will be accepted or rejected?

Answer 49

Accepted

Question 50

If the IRR is greater than the RRR/discount rate, the project will be accept or reject?

Answer 50

Accept

Question 51

If the IRR is less than the discount rate, that means NPV is Negative or positive

Answer 51

Negative

Question 52

What would happen to the IRR if the discount rate was increased or decreased?

Answer 52

NOTHING the IRR is independent of the RRR. However, the accept or reject decision could change.

Question 53

If cash flows are condensed overtime would the IRR increase or decrease would NPV increase or decrease

Answer 53

Increase | Increase

Question 54

shows how many dollars of return a project returns for every $1

Answer 54

Profitability index

Question 55

True/ False | Firms would not impose a required return of less than $1 as this rule would accept a negative NPV project

Answer 55

True

Question 56

Beta for the overall market is 1.0 | True or False

Answer 56

True

Question 57

A Beta of 1.3 means that this particular "risky" asset is 1.3 times as volatile or reactive to systematic (market wide) risk as the "average risky asset" True or False

Answer 57

True

Question 58

risk/return or relative riskiness a way to compare relative risk and return between different investments a lower CV is preferred for those who are risk adverse

Answer 58

Coefficient variation

Question 59

amount of return you expect from a stock based on the risk estimated return for a stock is LESS than ______ you reject the stock estimated return for a stock is more than _______ you buy the stock

Answer 59

Required Rate of Return

Question 60

The ___________ is the additional return an investor will receive (or expects to receive) from holding a risky market portfolio instead of risk-free assets.

Answer 60

Market Risk Premium

Question 61

non-diversifiable risk. This risk is the fluctuation of returns caused by macroeconomic factors that affect all risky assets.

Answer 61

Systematic (Market) Risk

Question 62

risk is the risk that something goes wrong on for a company or industry such as mismanagement, labor strikes, production of undesirable products,

Answer 62

Non Systematic (Unique) Risk