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Sample Questions Conceptual 1- The process by which smaller investment proposals of each of a firm's operational units are added up and treated as one big project is known as: A) Separation. B) Aggregation. C) Conglomeration. D) Appropriation. E) Striation. 2- The designated source(s) of external financing required to make the pro forma balance sheet balance is called the: A) Retained earnings account. B) Common stock account. C) Debt-equity ratio. D) Cash flow variable. E) Plug variable. 3- All else equal, an increase in a firm's dividend payout ratio will decrease its __________. I. sustainable growth rate II. internal growth rate III. external financing needed A) I only B) II only C) I and II only D) I and III only E) II and III only 4- The sustainable growth rate of a firm is best described as: A) The minimum growth rate achievable if the firm does not pay out any cash dividends. B) The minimum growth rate achievable if the firm maintains a constant equity multiplier. C) The maximum growth rate achievable without external financing of any kind. D) The maximum growth rate achievable without using any external equity financing, while maintaining a constant debt-equity ratio. E) The maximum growth rate achievable without any limits on the amount of debt financing used. 5- The percentage of sales approach to financial planning requires: A) All assets and liabilities change at the same rate as sales. B) The dividend policy remain unchanged from year to year. C) The firm be operating at full capacity. D) Separating accounts into those that vary with sales and those that do not. E) The firm's sales to increase each year. 6- Why is it important to determine if a firm is operating at full capacity or not? A) Because a firm that is operating at less than full capacity will not need any external financing. B) Because in a firm that is operating at less than full capacity, fixed assets will typically increase at the same percent as sales. C) Because a firm with excess capacity has some room to expand sales without increasing the investment in fixed assets. D) Because, for a given increase in sales, firms operating at less than full capacity will experience more rapid asset growth than firms that do operate at full capacity. E) Because only firms operating at full capacity can grow rapidly. 7- Sales growth _________________. A) will typically lead to growth in current assets B) will automatically lead to increases in long-term debt C) is the least important item to forecast in the financial planning process D) will require additions to net fixed assets for firms operating at less than full capacity E) of less than 10% will make EFN negative, creating a surplus 8- An efficient capital market is one in which: A) Brokerage commissions are zero. B) Taxes are irrelevant. C) Securities always offer a positive rate of return to investors. D) Security prices are guaranteed (by the Ontario Securities Commission) to be fair. E) Security prices reflect available information. 9- The hypothesis that market prices reflect all publicly-available information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. 10- If a company insider uses all of her knowledge about the company stock and still has no advantage in the marketplace over outside investors, the market has to be: A) Semi-strong form efficient. B) Strong form efficient. C) Weak form efficient. D) Overpriced. E) Underpriced. 11- Which of the following is true about risk and return? A) Riskier assets will, on average, earn lower returns. B) The reward for bearing risk is known as the standard deviation. C) Based on historical data, there is no reward for bearing risk. D) An increase in the risk of an investment will result in a decreased risk premium. E) In general, the higher the risk the higher the expected return. 12- IBM announces that earnings per share for the current quarter are $1.25; this figure is barely half of what investors and analysts expected. In an efficient market, the price of IBM stock will A) change immediately to reflect changes in investor expectations B) gradually fall over several days as investors assimilate the new information C) first fall, reflecting investors' surprise; then rise back somewhat as investors assimilate the new information D) probably not change at all E) fall only if there is additional unfavourable news about IBM announced at the same time 13- Suppose you purchase a stock expecting the price to rise in the coming year. After one year, your stock has actually decreased in value, due primarily to adverse information released during the year. Which of the following describes this result? A) This is not a violation of market efficiency. B) This is a violation of weak form efficiency. C) This is a violation of semi-strong form efficiency. D) This is a violation of strong form efficiency. E) This is a violation of all forms of market efficiency. 14- _________________ is one of the most commonly used measures of return volatility. A) The normal distribution B) The inflation rate C) The risk premium D) Standard deviation E) Return on investment 15- Risk that affects a large number of assets, each to a greater or lesser degree, is called: A) Idiosyncratic risk. B) Diversifiable risk. C) Systematic risk. D) Asset-specific risk. E) Total risk. 16- The principle of diversification tells us that: A) Concentrating an investment in two or three large stocks will eliminate all of your risk. B) Concentrating an investment in two or three large stocks will reduce your overall risk. C) Spreading an investment across many diverse assets cannot (in an efficient market) eliminate any risk. D) Spreading an investment across many diverse assets will eliminate all of the risk. E) Spreading an investment across many diverse assets will eliminate some of the risk 17- Which of the following is true regarding the beta coefficient? A) It is a measure of unsystematic risk. B) A beta greater than one represents lower systematic risk than the market. C) Generally speaking, the higher the beta the higher the expected return. D) A beta of one indicates an asset is totally risk-free. E) The risk premium of an asset will increase if the beta of that asset decreases 18- Which of the following is/are true for a stock with beta equal to 1.5? I. The stock has a 50% higher expected return than the average stock. II. Given a market risk premium of 10%, the expected return on the stock would be 15%. III. The stock has 50% more systematic risk than the average stock. A) I only B) II only C) III only D) I and III only E) I, II, and III 19- The principle of diversification states that spreading an investment over a number of assets will eliminate: A) All of the risk. B) All of the systematic risk and part of the unsystematic risk. C) All of the unsystematic risk and part of the systematic risk. D) Most of the systematic risk. E) Most of the unsystematic risk. 20- Standard deviation measures the ____ risk and beta measures the ____ risk of a portfolio. A) Unsystematic; systematic B) Systematic; unsystematic C) Unsystematic; total D) Total; unsystematic E) Total; systematic 21- The steeper the slope of the security market line, the A) Higher the risk-free rate of return. B) Lower the risk-free rate of return. C) Higher the market beta. D) Higher the risk premium E) Lower the risk premium. 22- The approach to computing the cost of equity financing which does not explicitly consider risk is called the: A) Weighted average cost of capital. B) After-tax cost of debt. C) Dividend growth model. D) Stock financing model. E) Security market line 23- Which of the following correctly describes the computation of the firm's weighted average cost of capital (WACC) ? A) (E/V) + RE + (D/V) + RD + (1 – TC) B) (E/V) RE (1 – TC) + (D/V) RD C) (D/V) RE + (E/V) RD (1 – TC) D) (E/V) + RE + (D/V) + RD E) (E/V) RE + (D/V) RD (1 – TC) 24- A firm has three divisions. A capital budgeting request has just come through for Division C showing a positive NPV at the firm's overall WACC. The financial manager of the firm knows that Division C is the riskiest of the three divisions. The financial manager should A) deny the request since it was computed in error B) approve the request since it has a positive NPV C) ask that the NPV be recomputed at a cost of capital appropriate for the division D) approve the request if neither of the other two divisions have any capital budgeting projects with positive NPVs E) subjectively reduce the NPV to reflect the difference in risk and then accept the project if NPV is still positive 25- A firm should consider using ________ approach if it only calculates the WACC for the firm as a whole, yet it has divisions with substantially different risk characteristics. A) an unbiased B) an empirical C) an objective D) a subjective E) a simulation 26- The weights placed on each source of financing when computing the WACC are based on the: A) Most recent book values available. B) The latest book values filed with the OSC. C) Market value of the equity portion and the face value of the debt portion. D) Market value of both the equity and the debt outstanding. E) Par value of the equity and the face value of the debt outstanding. 27- Which of the following is NOT true regarding a firm's cost of debt? A) The cost of debt must be adjusted lower due to the firm's tax deductibility of interest expense. B) The firm's cost of debt based on its past borrowing is known as its embedded debt cost. C) It is possible to determine a firm's cost of debt by using the SML. D) The coupon rate on outstanding debt is not necessarily the firm's current cost of debt. E) A firm's cost of equity is generally easier to calculate than a firm's cost of debt. 28- The sustainable growth rate is defined as: I Excluding additional equity financing. II Excluding any kind of external financing. III Including a variable debt-equity ratio. IV Including a constant debt-equity ratio. A) II only. B) I and III only. C) II and III only. D) I and IV only. E) II and IV only. 29- Which of the following is a basic policy element of financial planning? I. The capital budgeting decision II. The dividend policy decision III. The net working capital decision A) I only B) II only C) I and II only D) II and III only E) I, II, and III 30- In creating pro forma statements, if we assume that costs, assets, and short-term debt vary directly with changes in sales, that the payout ratio is fixed, and that the change in long-term debt only results from payments made as required on the debt contracts, then the "plug" required for the balance sheet to balance will probably be: A) Dividends. B) Total debt. C) Long-term debt. D) New equity sales. E) Retained earnings. 31- Assume a firm is currently operating at full capacity. Sales are forecast to increase by 20% next year. Management could do each of the following EXCEPT: A) Attempt to restrain sales growth so that no new fixed assets are needed. B) Increase the firm's investment in fixed assets to meet the added demand. C) Subcontract with other manufacturers to increase production and meet the added demand. D) Lease additional equipment to meet the added demand. E) Acquire more current assets in order to meet the added demand. 32- If your firm is currently operating at full capacity and you expect strong sales growth over the next few years, you should most likely: A) Expect that assets will not grow. B) Raise your dividend payout to accommodate the growth. C) Put off any further financial planning until sales growth moderates. D) Expect external financing will be needed. E) Expect the growth in retained earnings to outpace the growth in sales. 33- Which of the following statements about market efficiency is generally considered to be true? A) For inefficient markets, security prices will rapidly reflect new information. B) It is easy to forecast the direction of future security price changes in the short run. C) Short-run price changes occur independent of information coming to the market. D) On average, most stocks are mispriced. E) In the absence of legal constraints, investors with inside information will be able to earn excess returns. 34- You have discovered from looking at charts of past stock prices that if you buy just after a stock price has declined for three consecutive days, you make money every time! This is a violation of ________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock 35- Which of the following are included in the market prices if the market is semi-strong efficient? I. All historical information II. All insider information III. All public information IV. All information of any kind A) I only B) III only C) I and III only D) I, II, and III only E) I, II, III, and IV 36- If the stock market is weak form efficient, then an investor can NOT earn excess profits by: A) Trading on insider information. B) Trading on newly released public information. C) Identifying mispriced securities. D) Studying historical price patterns. E) Studying financial statements as they become available. 37- Last year you purchased a stock at $21.63 a share. Today you sold your shares at $23.01 after receiving your quarterly dividend. The total return on this stock consists of: A) A capital gain only. B) A capital loss only. C) A capital gain and a dividend yield. D) A capital loss and a dividend yield. E) A dividend yield and a risk-free rate of return. 38- Which of the following is true about calculating expected portfolio returns and variances? A) You need to calculate the weight of each asset relative to the total portfolio to calculate the portfolio return, but not to calculate the portfolio variance. B) Portfolio return can be calculated using the expected return and portfolio weight for each asset. C) The portfolio return is not needed to calculate the portfolio variance. D) The portfolio return and variance are independent of the possible states of nature. E) The portfolio variance is generally a weighted average of the variances of the individual assets in the portfolio. 39- The principle of diversification states that spreading an investment over a number of assets will eliminate: A) All of the risk. B) All of the systematic risk and part of the unsystematic risk. C) All of the unsystematic risk and part of the systematic risk. D) Most of the systematic risk. E) Most of the unsystematic risk. 40- The steeper the slope of the security market line, the A) Higher the risk-free rate of return. B) Lower the risk-free rate of return. C) Higher the market beta. D) Higher the risk premium E) Lower the risk premium. 41- In a highly diversified portfolio, the standard deviation of the portfolio will be equal to: A) Zero. B) One. C) The portfolio beta. D) The systematic risk. E) The risk premium of the portfolio. 42- The inclusion of thirty highly diverse securities in a portfolio eliminates the bulk of the ___ risk. A) Market B) Unique C) Unexpected D) Expected E) Inflation 43- Ajax Corp. has been operating as three separate divisions over the past ten years, although all capital budgeting decisions are ultimately made at the home office using the firm's overall WACC. Just recently, they discovered the divisions have significantly different risks. Which of the following is also likely to be true? A) The divisions are being rewarded for decreasing their risk. B) Higher earning divisions will be less risky than the lower earning divisions. C) Its low earning division tends to be ignored in capital allocation even though it tends to maintain lower levels of risk. D) The differences in risk among the divisions has no impact on the capital budgeting process. E) The highest divisional cost of capital will approximately equal the firm's overall cost of capital. 44- In using the ___________ approach to estimating the cost of capital for a division, an analyst proceeds by observing the returns for a firm whose operations are in the same risk class as the division. A) pure play B) conglomerate C) market specialist D) correspondent division E) parallel risk class 45- The relevant cost of debt for use in a WACC computation which will be used as the required rate of return for a new project should be the rate that is the: A) Average coupon rate for all outstanding bond issues. B) Average yield-to-call for all callable bond issues. C) After-tax weighted average yield-to-maturity of all outstanding bonds. D) After-tax yield-to-maturity of the highest rated bond available on the market. E) Average of the risk-free rate of return and the after-tax weighted average yield-to-maturity of all outstanding bonds. 46- A firm's WACC is applicable to those projects that: A) Are considered within one year of the date of the information used in the WACC computation. B) Are similar in risk to the current operations of the firm. C) Represent new avenues of business for the firm. D) Payback within the required period of time. E) Are pure plays in new areas of business. 47- A company has a market-to-book ratio that is greater than 1.0. If this company uses book values to determine their WACC, they will derive a value that is ______ the market based WACC. because _______ A) Equivalent to; the ratio of debt to equity is the same whether book values or market values are used. B) Greater than; the ratio of debt to equity will be greater than if the ratio was based on market values. C) Greater than; the ratio of debt to equity will be less than if the ratio was based on market values. D) Less than; the ratio of debt to equity will be greater than if the ratio was based on market values. E) Less than; the ratio of debt to equity will be less than if the ratio was based on market values. 48- Which one of the following would tend to have the greatest effect on the cost of equity? A) A 10% one-time increase in a firm's dividend B) A 10% increase in the growth rate of a firm's dividends C) The elimination of one dividend payment five years from now D) A 10% decline in the market value of a firm's common stock E) A 10% increase in the market value of a firm's common stock 49- Which one of the following will increase the WACC of a firm? A) An increase in the marginal tax B) An increase in the debt-equity ratio C) An increase in the risk-free rate of return D) A decrease in the level of risk of a project E) A decrease in the yield-to-maturity of the bonds 50- The amount raised to finance a project when new securities are issued can be defined as the: A) Total value of the new securities issued multiplied by the quantity of 1 minus the flotation cost expressed as a percentage of the amount raised. B) Cash needed to fund the project excluding any flotation costs. C) Cash needed to fund the project multiplied by the quantity of 1 minus the flotation cost expressed as a percentage. D) Total market value of the new securities minus the flotation cost. E) Outside amount needed for the project divided by the quantity of 1 minus the flotation cost expressed as a percentage of the amount raised.