Corporate Finance Review

Assume a firm accepts a positive net present value project. An analyst would be most justified in concluding that:

• the project will pay back within the required payback period.

• the present value of the expected cash flows is equal to the project’s cost.

• that all the projected cash flows will occur as expected.

• the stockholders’ value in the firm is expected to increase.

Assume a firm is more concerned about quickly recovering its initial investment than it is about the amount of value created. Accordingly, the firm is most likely to employ the ________ method of capital project analysis.

• internal rate of return

• net present value

• payback

• profitability index

The ________ measures the interrelationship between two securities.

• covariance

• standard deviation

• alpha coefficient

• variance

When computing the expected return on a portfolio of stocks, the portfolio weights are based on the:

• number of shares owned in each stock.

• price per share of each stock.

• market value of the total shares held in each stock.

• original amount invested in each stock.

The beta of a security is calculated by dividing the

• covariance of the security return with the market return by the variance of the market.

• correlation of the security return with the market return by the variance of the market.

• variance of the market by the covariance of the security return with the market return.

• covariance of the security return with the market return by the correlation of the security and market returns.

The primary purpose of portfolio diversification is to:

• increase returns and risks.

• eliminate all risks.

• eliminate asset-specific risk

• eliminate systematic risk.

The market risk premium is computed by:

• adding the risk-free rate of return to the inflation rate.

• adding the risk-free rate of return to the market rate of return.

• subtracting the risk-free rate of return from the inflation rate.

• subtracting the risk-free rate of return from the market rate of return.

When computing WACC, an analyst should use.

• pretax cost of debt because most corporations pay taxes at the same tax rate.

• pretax cost of debt because it is the actual rate the firm is paying its bondholders.

• current yield because it is based on the current market price of debt.

• aftertax cost of debt because interest is partially, if not fully, tax deductible.

What is the cost of equity for a firm that has a beta of 1.22 if the risk-free rate of return is 1.4 percent and the expected market return is 6.6 percent?

• 6.6%

• 7.74%

• 8.27%

• 7.60%

Companies will generally have a ____ beta if their:

• low; stock price is relatively low.

• high; sales are highly dependent on the market cycle.

• high; sales are growing at a steady rate of increase.

• high; sales are high compared to other firms in their industry.