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Which of the following is/are an advantage of incorporation?

Access to capital markets

Limited liability

Unlimited life

All of the above

In a corporation, the ultimate decisions regarding business matters are made by:

the Board of Directors.

debt holders.

shareholders.

investors.

The person charged with running the corporation by instituting the rules and policies set by the board of directors is called:

the chief operating officer.

the company president.

the chief executive officer.

the chief financial officer

The Principal-Agent Problem arises:

because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest.

because of the separation of ownership and control in a corporation

Both A and B

None of the above

A ___________ is when a rich individual or organization purchases a large fraction of the stock of a poorly performing firm and in doing so gets enough votes to replace the board of directors and the CEO.

shareholder proposal

leveraged buyout

shareholder action

hostile takeover

If you buy shares of Coca-Cola on the primary market

Coca-Cola receives the money because the company has issued new shares

you buy the shares from another investor who decided to sell the shares

you buy the shares from the New York Stock Exchange

you buy the shares from the Federal Reserve

If you buy shares of Coca-Cola on the secondary market

Coca-Cola receives the money because the company has issued new shares.

you buy the shares from another investor who decided to sell the shares

you buy the shares from the New York Stock Exchange.

you buy the shares from the Federal Reserve

Which of the following statements is FALSE?

About 75% of firms surveyed used the NPV rule for making investment decisions.

If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.

To decide whether to invest using the NPV rule, we need to know the cost of capital.

NPV is positive only for discount rates greater than the internal rate of return

Which of the following statements is FALSE?

In general, the difference between the cost of capital and the IRR is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision

The IRR can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital

If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate

If the cost of capital estimate is more than the IRR, the NPV will be positive.

Which of the following statements is FALSE?

The IRR investment rule will identify the correct decision in many, but not all, situations

By setting the NPV equal to zero and solving for r, we find the IRR.

If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate

The simplest investment rule is the NPV investment rule.

When using the internal rate of return (IRR) investment rule, we compare:

the average return on the investment opportunity to returns on all other investment opportunities in the market.

the average return on the investment opportunity to returns on other alternatives in the market with equivalent risk and maturity.

the NPV of the investment opportunity to the average return on the investment opportunity

the average return on the investment opportunity to the risk-free rate of return.

Which of the following statements is FALSE?

In general, the IRR rule works for a stand-alone project if all of the project’s positive cash flows precede its negative cash flows

There is no easy fix for the IRR rule when there are multiple IRRs.

The payback rule is primarily used because of its simplicity

No investment rule that ignores the set of alternative investments can be optimal

Which of the following statements is FALSE?

Problems can arise using the IRR method when the mutually exclusive investments have different cash flow patterns.

The IRR is affected by the scale of the investment opportunity.

Multiple incremental IRRs might exist.

The incremental IRR rule assumes that the riskiness of the two projects is the same.

Consider two mutually exclusive projects A & B. If you subtract the cash flows of opportunity B from the cash flows of opportunity A, then you should:

take opportunity A if the regular IRR exceeds the cost of capital

take opportunity A if the incremental IRR exceeds the cost of capital.

take opportunity B if the regular IRR exceeds the cost of capital.

take opportunity B if the incremental IRR exceeds the cost of capital.

Which of the following statements is FALSE?

If there is a fixed supply of a resource available, you should rank projects by the profitability index, selecting the project with the lowest profitability index first and working your way down the list until the resource is consumed.

Practitioners often use the profitability index to identify the optimal combination of projects when there is a fixed supply of resources

If there is a fixed supply of resources available, so that you cannot undertake all possible opportunities, then simply picking the highest NPV opportunity might not lead to the best decision.

The profitability index is calculated as the NPV divided by the resources consumed by the project

Which of the following statements is FALSE?

The profitability index measures the value created in terms of NPV per unit of resource consumed

The profitability index is the ratio of value created to resources consumed.

The profitability index can be easily adapted for determining the correct investment decisions when multiple resource constraints exist

The profitability index measures the "bang for your buck."

Which of the following statements is FALSE?

The firm deducts a fraction of the investments in plant, property, and equipment each year as depreciation.

If securities are fairly priced, the net present value of a fixed set of cash flows is independent of how those cash flows are financed.

Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk costs in capital budgeting analysis.

A good rule to remember is that if our decision does not affect a cash flow then the cash flow should not affect our decision.

Which of the following costs would you consider when making a capital budgeting decision?

Sunk cost

Opportunity cost

Interest expense

Fixed overhead cost

Which of the following statements is FALSE?

Because value is lost when a resource is used by another project, we should include the opportunity cost as an incremental cost of the project

Sunk costs are incremental with respect to the current decision regarding the project and should be included in its analysis

Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation.

When computing the incremental earnings of an investment decision, we should include all changes between the firm’s earnings with the project versus without the project.

Which of the following cash flows are relevant incremental
cash flows for a project that you are currently considering investing in?

The tax savings brought about by the project’s depreciation expense

The cost of a marketing survey you conducted to determine demand for the proposed project

Interest payments on debt used to finance the project

Research and Development expenditures you have made

Which of the following statements is FALSE?

The break-even level of an input is the level for which the investment has an IRR of zero.

The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital

When evaluating a capital budgeting project, financial managers should make the decision that maximizes NPV.

Sensitivity analysis reveals which aspects of the project are most critical when we are actually managing the project.

Which of the following statements is FALSE?

Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our NPV analysis for the project.

To compute the NPV for a project, you need to estimate the incremental cash flows and choose a discount rate

Estimates of the cash flows and cost of capital are often subject to significant uncertainty.

When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.

Which of the following statements is FALSE?

We can use scenario analysis to evaluate alternative pricing strategies for our project.

Scenario analysis considers the effect on NPV of changing multiple project parameters.

The difference between the IRR of a project and the cost of capital tells you how much error in the cost of capital it would take to change the investment decision.

Scenario analysis breaks the NPV calculation into its component assumptions and shows how the NPV varies as each one of the underlying assumptions change.

The difference between scenario analysis and sensitivity analysis is that:

scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV

only sensitivity analysis allows us to change our estimated inputs of our NPV analysis.

only scenario analysis considers the effect on NPV of changing multiple project parameters.

only scenario analysis breaks the NPV calculation into its component assumptions.

An exploration of the effect on NPV of changing multiple
project parameters is called:

scenario analysis.

IRR analysis.

accounting break-even analysis

sensitivity analysis

An analysis that breaks the NPV calculation into its component assumptions and shows how the NPV varies as one of the underlying assumptions is changed is called:

scenario analysis.

IRR analysis

accounting break-even analysis.

sensitivity analysis.

Which of the following is NOT a way that a firm can increase
its dividend?

By increasing its retention rate

By decreasing its shares outstanding

By increasing its earnings (net income)

By increasing its dividend payout rate

Which of the following statements is false regarding profitable and unprofitable growth?

If a firm wants to increase its share price, it must cut its dividend and invest more.

If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend.

A firm can increase its growth rate by retaining more of its earnings

Cutting the firm’s dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV

Which of the following statements is FALSE?

Estimating dividends, especially for the distant future, is difficult

A firm can only pay out its earnings to investors or reinvest their earnings.

Successful young firms often have high initial earnings growth rates

According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the growth rate.

NoGrowth industries presently pays an annual dividend of
$1.50 per share and it is expected that these dividend payments will continue
indefinitely. If NoGrowth’s equity cost of capital is 12%, then the value
of a share of NoGrowth’s stock is closest to:

$10.00

$15.00

$14.00

$12.50

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 12%. Luther Industries dividends are expected to grow at a constant rate indefinitely. The growth rate of Luther’s dividends is closest to:

7.5%

5.5%

16.5%

12%

You expect KT Industries (KTI) will have earnings per share
of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI’s return on new investments is
15% and their equity cost of capital is 12%. The value of a share of KTI’s stock is closest to:

$39.25

$20.00

$33.35

$12.50

Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share and use the extra funds to expand its operations. Kinston’s dividends were expected to grow at a 2% rate, and its share price was $37.50. With the new expansion, Kinston dividends are expected to grow at a 5% rate. Kinston’s share price following this announcement should be:

$20.00

$30.00

$37.50

$40.00

Which of the following statements is FALSE?

Even two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale

In the method of comparables, we estimate the value of the firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future

Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm

A valuation multiple is a ratio of some measure of the firm’s scale to the value of the firm

Which of the following statements is FALSE?

The most common valuation multiple is the price-earnings (P/E) ratio

You should be willing to pay proportionally more for a stock with lower current earnings.

A firm’s P/E ratio is equal to the share price divided by its earnings per share

The intuition behind the use of the P/E ratio is that when you buy a stock, you are in sense buying the rights to the firm’s future earnings and differences in the scale of the firms’ earnings are likely to persist

Which of the following statements is FALSE?

Because the enterprise value represents the entire value of the firm before the firm pays its debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows after interest payments are made

We can compute a firm’s P/E ratio by using either trailing earnings or forward earnings with the resulting ratio called the trailing P/E or forward P/E.

It is common practice to use valuation multiples based on the firm’s enterprise value

Using a valuation multiple based on comparables is best viewed as a "shortcut" to the discounted cash flow method of valuation

Which of the following statements is FALSE?

The fact that a firm has an exceptional management team, has developed an efficient manufacturing process, or has just secured a patent on a new technology is ignored when we apply a valuation multiple.

Valuation multiples have the advantage that they allow us to incorporate specific information about the firm’s cost of capital or future growth.

For firms with substantial tangible assets, the ratio of price to book value of equity per share is sometimes used.

Using multiples will not help us determine if an entire industry is overvalued.

Which of the following statements is FALSE?

Because capital expenditures can vary substantially from period to period, most practitioners rely on enterprise value to free cash flow multiples

Common multiples to consider are enterprise value to EBIT, EBITDA, and free cash flow.

If two stocks have the same payout and EPS growth rates as well as equivalent risk, then they should have the same P/E ratio.

Looking at enterprise value as a multiple of sales can be useful if it is reasonable to assume that the firms will maintain similar margins in the future.

You expect Whirlpool Corporation (WHR) to have earnings per share of $6.10 over the coming year. If Whirlpool stock is currently trading at $87.00 per share, then Whirlpool’s P/E ratio is closest to:

17.00

13.50

14.25

7.00

Which of the following statements is FALSE?

Modigliani and Miller’s conclusion verified the common view, which stated that even with perfect capital markets, leverage would affect a firm’s value

We can evaluate the relationship between risk and return more formally by computing the sensitivity of each security’s return to the systematic risk of the economy

Investors in levered equity require a higher expected return to compensate for its increased risk.

Leverage increases the risk of equity even when there is no risk that the firm will default.

Corporate Finance

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