Set of flashcards Corporate Finance

Flashcards	136
Language	Deutsch
Category	Finance
Level	University
Created / Updated	02.12.2024 / 15.12.2024
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Which of the following statements is false?

Real estate firms are likely to have low costs of financial distress, as much of their value derives from assets that can be sold relatively easily.

For low levels of debt, the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield.

Firms whose value and cash flows are very volatile (for example, semiconductor firms) must have much higher levels of debt to avoid a significant risk of default.

The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.

Real estate firms are likely to have low costs of financial distress, as much of their value derives from assets that can be sold relatively easily.

For low levels of debt, the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield.

Firms whose value and cash flows are very volatile (for example, semiconductor firms) must have much higher levels of debt to avoid a significant risk of default.

The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.

Suppose a firm has a loan of 2 million euros due next year. All else equal, its assets will be worth 1.8 million euros at that time and it will default on its debt. Now consider the managers, who are consistently seeking to create value to shareholders, are evaluating an opportunity that requires an investment of 150 thousand euros and will generate 100% risk free return. On top of this, it is known that equity holders will need to contribute themselves with the 150 thousand euros in new capital. If the risk-free rate is 5%, which of the following statements best reflect the expected scenario for the firm.

The firm will invest in the project capturing 136 thousand euros for equity holders

The firm will invest in the project capturing 55 thousand euros for equity holders

The firm will not invest in the project that would have a negative value for equity holders of 136 thousand euros

The firm will not invest in the project that would have a negative value for equity holders of 55 thousand euros

The firm will invest in the project capturing 136 thousand euros for equity holders

The firm will invest in the project capturing 55 thousand euros for equity holders

The firm will not invest in the project that would have a negative value for equity holders of 136 thousand euros

The firm will not invest in the project that would have a negative value for equity holders of 55 thousand euros

Being the owner of a piece of land near the sea, you decide to purchase insurance that will pay you 500 million euros in the event the land is destroyed by a tsunami, knowing the likelihood for this to happen is 0.05%. Given the beta of an insurance for these cases if -0.2 what is the actuarially fair premium, if the risk-free rate is 3% and the expected return of the market is 8%?

250 thousand euros

247 thousand euros

245 thousand euros

240 thousand euros

250 thousand euros

247 thousand euros

245 thousand euros

240 thousand euros

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

By increasing its retention rate

By decreasing its shares outstanding

By increasing its earnings (net income)

By increasing its dividend payout rate

A type of agency problem that results in shareholders gaining from decisions that
increase the risk of the firm sufficiently, even if they have negative NPV is:

Asset substitution.

Debt overhang.

Underinvestment.

Cashing out.

Asset substitution.

Debt overhang.

Underinvestment.

Cashing out.

9. Consider the following statements:
i. The existence of at least one incremental IRR implies that both projects have
at least one IRR.
ii. At least one IRR exists if the project with positive NPV has an outflow at time
zero.
iii. The profitability index method provides an accurate answer if the constraint is
fully saturated.

Only (i) and (iii) are true

Only (ii) and (iii) are true

All statements are true

All statements are false

Only (i) and (iii) are true

Only (ii) and (iii) are true

All statements are true

All statements are false

A company’s management believes the shares are undervalued. What is the order
of the financing sources that the company will choose?

Retained earnings -> Debt -> Equity

Debt -> Retained earnings -> Equity

Equity -> Debt -> Retained earning

Retained earnings -> Equity -> Debt

Retained earnings -> Debt -> Equity

Debt -> Retained earnings -> Equity

Equity -> Debt -> Retained earning

Retained earnings -> Equity -> Debt

Rejecting an investment today forever might not be a good choice because:

(I) The size of the firm will decline.
(II) There are always errors in the estimation of the NPVs.
(III) The option value is negative.
(IV) The company is foregoing future rights or the option to deepen the investment if economic and industry conditions change for the better

I only

II only

I, II, and III only

IV only

I only

II only

I, II, and III only

IV only

Consider the following three statements:
(1) A real option is always present if there is uncertainty about the future development
of the market (e.g., demand)
(2) The option to abandon a Project is akin to a call option
(3) Real options are usually easier to identify and value than financial options

Only (1) is correct.

Only (1) and (2) are correct

All statements are correct.

All statements are incorrect

Only (1) is correct.

Only (1) and (2) are correct

All statements are correct.

All statements are incorrect

Analysts expect Pineapple Inc. to face increased competition on the beverage market, which would result in Pineapple Inc. losing 5% of their market share over the next two years, and then to have stable income with no growth forever. Currently the company follows a target debt-to-value strategy. Tomorrow it is planning to hold a press conference, where the CEO will announce that the company will change its debt structure strategy to permanent debt in three years. How will the value of the shares change after the press conference? Assume perfect capital markets

The share price will decrease

The share price will remain the same

The share price will increase

The market reaction is not certain

The share price will decrease

The share price will remain the same

The share price will increase

The market reaction is not certain

A project has an up-front cost of $100,000. The project's WACC is 12%, and its net present value is $10,000. Which of the following statements is most correct?

The project should be rejected since its return is less than the WACC.

The project's internal rate of return is greater than 12 percent.

All of the statements above are correct

None of the statements above is correct

The project should be rejected since its return is less than the WACC.

The project's internal rate of return is greater than 12 percent.

All of the statements above are correct

None of the statements above is correct

In M&M’s perfect capital markets which of the following statements is FALSE?

With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of the firm.

Leverage does not increase the risk of equity if there is no risk that the firm will default

It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity.

In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets.

With perfect capital markets, leverage merely changes the allocation of cash flows between debt and equity, without altering the total cash flows of the firm.

Leverage does not increase the risk of equity if there is no risk that the firm will default

It is inappropriate to discount the cash flows of levered equity at the same discount rate that we use for unlevered equity.

In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets.

Which one of these statements about costs of financial distress is
CORRECT?

Expenses for lawyers, accountants, restructuring advisors, etc. are indirect costs associated with legal bankruptcy.

Fire sales refer to companies in distress selling their assets at prices equal to or above their fair values

Time that the management spends dealing with creditors cannot be counted as cost of financial distress

Indirect costs of financial distress are realized before the firm files for bankruptcy

Expenses for lawyers, accountants, restructuring advisors, etc. are indirect costs associated with legal bankruptcy.

Fire sales refer to companies in distress selling their assets at prices equal to or above their fair values

Time that the management spends dealing with creditors cannot be counted as cost of financial distress

Indirect costs of financial distress are realized before the firm files for bankruptcy

According to the tradeoff theory, the optimal capital structure tends to include MORE debt for firms with:

the highest depreciation deductions.

the lowest marginal tax rate.

low probabilities of financial distress

less taxable income

the highest depreciation deductions.

the lowest marginal tax rate.

low probabilities of financial distress

less taxable income

Which of the following statements regarding recapitalizations is FALSE?

With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front.

The share price always rises after the completion of the recapitalization.

Recapitalization changes cost of equity

In the presence of corporate taxes, we include the interest tax shield as one of the firm's assets on its market value balance sheet.

With a recapitalization, even though leverage reduces the total value of equity, shareholders capture the benefits of the interest tax shield up front.

The share price always rises after the completion of the recapitalization.

Recapitalization changes cost of equity

In the presence of corporate taxes, we include the interest tax shield as one of the firm's assets on its market value balance sheet.

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

Access to capital markets

Limited liability

Unlimited life

All of the above

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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.

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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

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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

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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

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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

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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

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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

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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.

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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.

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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.

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

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.

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.

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

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

Corporate Finance

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