True/False questions:
Problem 1. Diversification eliminates unsystematic risk. (According to portfolio the theory and CAPM.)
Problem 2. With as little as 10 or less securities, we can eliminate a significant portion of diversifiable risk or unsystematic risk. (According to portfolio the theory and CAPM.)
Problem 3. The greater the risk of expected cash inflows, the lower the discount rate we should use to determine the net present value (NPV).
Problem 4. The Modified Internal Rate of Return (MIRR) assumes that a project's cash inflows will be reinvested at the project's internal rate of return.
Problem 5. Using the CAPM to estimate the cost of equity capital assumes only systematic risk is relevant in the pricing of risky assets.
Problem 6. The greater the beta of a company, the higher its cost of equity capital, if everything else holds equal. (According to portfolio the theory and CAPM.)
Problem 7. An increase in perceived risk (i.e. market risk) will cause the price of a risky asset to decline.
Problem 8. Earning an economic rate of return that is greater than the cost of capital will create a value.
Problem 9. The greater the default risk premium, the greater the required rate of return on debt.
Problem 10. The risk (and after-tax cost) to holders or owners of preferred stock is higher or greater than the risk to owners of debt in the same company.
Problem 11. An increase in economic or political risk in a country would increase the cost of capital to companies in that country.
Problem 12. The weighted average cost of capital falls as the firm increases the debt/equity ratio toward its optimal capital structure because investors value the tax deductibility of interest.
Problem 13. The greater the uncertainty about a company's net operating income or EBIT, the greater the variability of its free cash flows.
Problem 14. According to maturity-matching principle long-term (permanent) assets should be financed with long-term sources of capital.
Problem 15. In ranking good independent projects, we should rank projects from highest to lowest internal rate of return.
Problem 16. Equity represented by retained earnings has a lower cost that equity from newly issued stock.
Problem 17. An increase in the financial risk of a company would cause its optimal debt/equity ratio to decrease.
Problem 18. Equity or stockholders have greater risk than creditors of the same company.
Problem 19. An increase in the variable cost per unit will increase the (accounting) break-even point for the company.
Problem 20. Speeding up the cash inflows (i.e. getting the cash flows earlier in time) that we receive from a project will increase the project's NPV.
Problem 21. The greater the debt/equity ratio, the greater the cost of levered equity, if everything else holds equal (according to the MM theory).
Problem 22. An increase in liquidity (i.e., a reduction in trading costs) lowers a firm's cost of capital.
Problem 23. The relationship between fixed and variable costs in production results in operating leverage.
Problem 24. Retained earnings have a cost that represents an opportunity cost if earnings are reinvested
Problem 25. Interest paid by corporation is a tax deduction for the paying corporation, but dividends paid are not deductible.
Problem 26. Retained earnings are the cash that has been generated by the firm through its operations which has not been paid out to stockholders as dividends.
Problem 27. Accounts payable, accruals, and deferred taxes are not sources of funding that come from investors, so they are not included in the calculation of the cost of capital.
Problem 28. Since capital gains can be deferred, the tax rate on dividends is greater than the effective tax rate on capital gains.
Problem 29. On its 1999 balance sheet, Sherman Books showed a balance of retained earnings equal to $510 million. On its 2000 balance sheet, the balance of retained earnings was also equal to $510 million. If the company's net income was $200 million, the dividend paid must have also equaled $200 million.
Problem 30. The stand-along risk is the project's risk if it were the firm's only asset.
Problem 31. Free cash flow is the amount of cash flow available for distribution to all investors after making all necessary investments (in fixed assets and working capital) to support operations.
Problem 32. Net operating working capital (NOWC) is equal to the operating current assets minus the operating current liabilities.
Problem 33. Net operating profit after taxes (NOPAT) is the amount of profit a company would have from its operations if it had no interest income or interest expenses.
Problem 34. The higher the assets to sales ratio (i.e. the capital intensity ratio) the more additional funds needed to support a growth in sales.
Problem 35. An equal percentage increase or decrease in the required market return on a bond will have an unequal dollar change in the market price of the bond.