Test bank for essentials of corporate finance 7th edition, stephen a. ross

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Test Bank for Essentials of Corporate

Finance, 7th Edition: Stephen A. Ross

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Chapter 1: Introduction to Financial Management

1. Tim has been promoted and is now in charge of all fixed asset purchases. In other words, Tim

is in charge of:

A. capital structure management.

B. asset allocation.

C. risk management.

D. capital budgeting.

E. working capital management.

2. Stadford, Inc. is financed with 40 percent debt and 60 percent equity. This mixture of debt

and equity is referred to as the firm's:

A. capital structure.

B. capital budget.

C. asset allocation.

D. working capital.

E. risk structure.

3. Lester's BBQ has $121,000 in current assets and $109,000 in current liabilities. These values

as referred to as the firm's:

A. capital structure.

B. cash equivalents.

C. working capital.

D. net assets.

E. fixed accounts

4. Margie opened a used book store and is both the 100 percent owner and the store's manager.

Which type of business entity does Margie own if she is personally liable for all the store's

debts?

A. Sole proprietorship

B. Limited partnership

C. Corporation

D. Joint stock company

E. General partnership

5. Will and Bill both enjoy sunshine, water, and surfboards. Thus, the two friends decided to

create a business together renting surfboards, paddle boats, and inflatable devices in California.

Will and Bill will equally share in the decision making and in the profits or losses. Which type of

business did they create if they both have full personal liability for the firm's debts?

A. Sole proprietorship

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B. Limited partnership

C. Corporation

D. Joint stock company

E. General partnership

6. Todd and Cathy created a firm that is a separate legal entity and will share ownership of that

firm on a 50/50 basis. Which type of entity did they create if they have no personal liability for

the firm's debts?

A. Limited partnership

B. Corporation

C. Sole proprietorship

D. General partnership

E. Public company

7. The potential conflict of interest between a firm's owners and its managers is referred to as

which type of conflict?

A. Organizational

B. Structure

C. Formation

D. Agency

E. Territorial

8. The federal government has a tax claim on the cash flows of The Window Store. This claim is

defined as a claim by one of the firm's:

A. residual owners.

B. shareholders.

C. financiers.

D. provisional partners.

E. stakeholders.

9. The "Say on Pay" bill requires corporations to do which one of the following?

A. Give the chairman of the board the final say on executive pay

B. Give the firm's creditors a nonbinding say on executive pay

C. Give the firm's creditors a binding say on executive pay

D. Give shareholders a nonbinding vote on executive pay

E. Give shareholders a binding vote on executive pay

10. In 2009, the Obama administration established a maximum limit on executive salaries for

firms that received bailout funds. What was the amount of that salary limit?

A. $250,000

B. $500,000

C. $750,000

D. $1,000,000

E. $1,500,000



Chapter 2: Financial Statements, Taxes, and Cash Flow

1. Net working capital is defined as:

A. the depreciated book value of a firm's fixed assets.

B. the value of a firm's current assets.

C. available cash minus current liabilities.

D. total assets minus total liabilities.

E. current assets minus current liabilities.

2. The accounting statement which measures the revenues, expenses, and net income of a firm

over a period of time is called the:

A. statement of cash flows.

B. income statement.

C. GAAP statement.

D. balance sheet.

E. net working capital schedule.

3. The financial statement that summarizes a firm's accounting value as of a particular date is

called the:

A. income statement.

B. cash flow statement.

C. liquidity position.

D. balance sheet.

E. periodic operating statement.

4. Which one of the following decreases net income but does not affect the operating cash flow

of a firm which owes no taxes for the current year?

A. Indirect cost

B. Direct cost

C. Noncash item

D. Period cost

E. Variable cost

5. Which one of the following terms is defined as the total tax paid divided by the total taxable

income?

A. Average tax rate

B. Variable tax rate

C. Marginal tax rate

D. Absolute tax rate

E. Contingent tax rate

6. Which one of the following is the tax rate that applies to the next dollar of taxable income that

a firm earns?

A. Average tax rate

B. Variable tax rate

C. Marginal tax rate

D. Absolute tax rate

E. Contingent tax rate



7. Cash flow from assets is defined as:

A. the cash flow to shareholders minus the cash flow to creditors.

B. operating cash flow plus the cash flow to creditors plus the cash flow to shareholders.

C. operating cash flow minus the change in net working capital minus net capital spending.

D. operating cash flow plus net capital spending plus the change in net working capital.

E. cash flow to shareholders minus net capital spending plus the change in net working capital.

8. Operating cash flow is defined as:

A. a firm's net profit over a specified period of time.

B. the cash that a firm generates from its normal business activities.

C. a firm's operating margin.

D. the change in the net working capital over a stated period of time.

E. the cash that is generated and added to retained earnings.

9. Which one of the following has nearly the same meaning as free cash flow?

A. Net income

B. Cash flow from assets

C. Operating cash flow

D. Cash flow to shareholders

E. Addition to retained earnings

10. Cash flow to creditors is defined as:

A. interest paid minus net new borrowing.

B. interest paid plus net new borrowing.

C. the operating cash flow minus net capital spending minus change in net working capital.

D. dividends paid plus net new borrowing.

E. cash flow from assets plus net new equity.

Chapter 3: Working with Financial Statements

1. Common-size financial statements present all balance sheet account values as a percentage of:

A. the forecasted budget.

B. sales.

C. total equity.

D. total assets.

E. last year's account value.

2. The ratios that are based on financial statement values and used for comparison purposes are

called:

A. financial ratios.

B. industrial statistics.

C. equity standards.

D. accounting returns.

E. analytical standards.



3. The Du Pont identity can be totally defined by which one of the following?

A. Return on equity, total asset turnover, and equity multiplier

B. Equity multiplier and return on assets

C. Profit margin and return on equity

D. Total asset turnover, profit margin, and debt-equity ratio

E. Equity multiplier, return on assets, and profit margin

4. Which one of the following is the maximum growth rate that a firm can achieve without any

additional external financing?

A. Du Pont rate

B. External growth rate

C. Sustainable growth rate

D. Internal growth rate

E. Cash flow rate

5. The sustainable growth rate is defined as the maximum rate at which a firm can grow given

which of the following conditions?

A. No new external financing of any kind

B. No new debt but additional external equity equal to the increase in retained earnings

C. New debt and external equity in equal proportions

D. New debt and external equity, provided the debt-equity ratio remains constant

E. No new equity and a constant debt-equity ratio

6. Which one of the following is the abbreviation for the U.S. government coding system that

classifies a firm by its specific type of business operations?

A. BEC

B. SED

C. BID

D. SIC

E. SBC

7. Builder's Outlet just hired a new chief financial officer. To get a feel for the company, she

wants to compare the firm's sales and costs over the past 3 years determine if any trends are

present and also determine where the firm might need to make changes. Which one of the

following statements will best suit her purposes?

A. Income statement

B. Balance sheet

C. Common-size income statement

D. Common-size balance sheet

E. Statement of cash flows

8. A common-size balance sheet helps financial managers determine:

A. which customers are paying on a timely basis.

B. if costs are increasing faster or slower than sales.

C. if changes are occurring in a firm's mix of assets.

D. if a firm is generating more or less sales per dollar of assets than in prior years.

E. the rate at which the firm's dividends are changing.



9. High Tower Pharmacy pays a fixed percentage of its net income out to its shareholders in the

form of annual dividends. Given this, the percent shown on a common-size income statement for

the dividend account will:

A. remain constant over time.

B. be equal to the dividend amount divided by the net income.

C. vary in direct relation to the net profit percentage.

D. vary in direct relation to changes in the sales level.

E. vary but not in direct relation to any other variable.

10. Which one of the following transactions will increase the liquidity of a firm?

A. Cash purchase of new production equipment

B. Payment of an account payable

C. Cash purchase of inventory

D. Credit sale of inventory at cost

E. Cash payment of employee wages

Chapter 4: Introduction to Valuation: The Time Value of Money

1. Martha is investing $5 today at 6 percent interest so she can have $10 later. The $10 is referred

to as the:

A. true value.

B. future value.

C. present value.

D. discounted value.

E. complex value.

2. Tom earned $120 in interest on his savings account last year. Tom has decided to leave the

$120 in his account so that he can earn interest on the $120 this year. This process of earning

interest on prior interest earnings is called:

A. discounting.

B. compounding.

C. duplicating.

D. multiplying.

E. indexing.

3. Jamie earned $180 in interest on her savings account last year. She has decided to leave the

$180 in her account so that she can earn interest on the $180 this year. The interest Jamie earns

this year on this $180 is referred to as:

A. simple interest.

B. complex interest.

C. accrued interest.

D. interest on interest.

E. discounted interest.



4. Lester had $6,270 in his savings account at the beginning of this year. This amount includes

both the $6,000 he originally invested at the beginning of last year plus the $270 he earned in

interest last year. This year, Lester earned a total of $282.15 in interest even though the interest

rate on the account remained constant. This $282.15 is best described as:

A. simple interest.

B. interest on interest.

C. discounted interest.

D. complex interest.

E. compound interest.

5. By definition, a bank that pays simple interest on a savings account will pay interest:

A. only at the beginning of the investment period.

B. on interest.

C. only on the principal amount originally invested.

D. on both the principal amount and the reinvested interest.

E. only if all previous interest payments are reinvested.

6. Sue needs to invest $3,626 today in order for her savings account to be worth $5,000 six years

from now. Which one of the following terms refers to the $3,626?

A. Present value

B. Compound value

C. Future value

D. Complex value

E. Factor value

7. Todd will be receiving a $10,000 bonus one year from now. The process of determining how

much that bonus is worth today is called:

A. aggregating.

B. discounting.

C. simplifying.

D. compounding.

E. extrapolating.

8. The interest rate used to compute the present value of a future cash flow is called the:

A. prime rate.

B. current rate.

C. discount rate.

D. compound rate.

E. simple rate.

9. Computing the present value of a future cash flow to determine what that cash flow is worth

today is called:

A. compounding.

B. factoring.

C. time valuation.

D. simple cash flow valuation.

E. discounted cash flow valuation.



10. Sara is investing $1,000 today. Which one of the following will increase the future value of

that amount?

A. Shortening the investment time period

B. Paying interest only on the principal amount

C. Paying simple interest rather than compound interest

D. Paying interest only at the end of the investment period rather than throughout the investment

period

E. Increasing the interest rate

Chapter 5: Discounted Cash Flow Valuation

1. Travis is buying a car and will finance it with a loan which requires monthly payments of

$265 for the next 4 years. His car payments can be described by which one of the following

terms?

A. Perpetuity

B. Annuity

C. Consol

D. Lump sum

E. Factor

2. Janis just won a scholarship that will pay her $500 a month, starting today, and continuing for

the next 48 months. Which one of the following terms best describes these scholarship

payments?

A. Ordinary annuity

B. Annuity due

C. Consol

D. Ordinary perpetuity

E. Perpetuity due

3. The Jones Brothers recently established a trust fund that will provide annual scholarships of

$12,000 indefinitely. These annual scholarships can best be described by which one of the

following terms?

A. Ordinary annuity

B. Annuity due

C. Amortized payment

D. Perpetuity

E. Continuation

4. A perpetuity in Canada is frequently referred to as which one of the following?

A. Consul

B. Infinity

C. Forever cash

D. Dowry

E. Forevermore



5. The stated interest rate is the interest rate expressed:

A. as if it were compounded one time per year.

B. as the quoted rate compounded by 12 periods per year.

C. in terms of the rate charged per day.

D. in terms of the interest payment made each period.

E. in terms of an effective rate.

6. Anna pays 1.5 percent interest monthly on her credit card account. When the interest rate on

that debt is expressed as if it were compounded only annually, the rate would be referred to as

the:

A. annual percentage rate.

B. compounded rate.

C. quoted rate.

D. stated rate.

E. effective annual rate.

7. Lee pays one percent per month interest on his credit card account. When his monthly rate is

multiplied by 12, the resulting answer is referred to as the:

A. annual percentage rate.

B. compounded rate.

C. effective annual rate.

D. perpetual rate.

E. simple rate.

8. Which one of the following will decrease the present value of an annuity?

A. Increase in the annuity's future value

B. Increase in the payment amount

C. Increase in the time period

D. Decrease in the discount rate

E. Decrease in the annuity payment

9. Christie is buying a new car today and is paying a $500 cash down payment. She will finance

the balance at 7.25 percent interest. Her loan requires 36 equal monthly payments of $450 each

with the first payment due 30 days from today. Which one of the following statements is correct

concerning this purchase?

A. The present value of the car is equal to $500 + (36 $450).

B. The $500 is the present value of the purchase.

C. The car loan is an annuity due.

D. To compute the initial loan amount, you must use a monthly interest rate.

E. The future value of the loan is equal to 36 $450.



10. Which one of the following statements is true concerning annuities?

A. All else equal, an ordinary annuity is more valuable than an annuity due.

B. All else equal, a decrease in the number of payments increases the future value of an annuity

due.

C. An annuity with payments at the beginning of each period is called an ordinary annuity.

D. All else equal, an increase in the discount rate decreases the present value and increases the

future value of an annuity.

E. All else equal, an increase in the number of annuity payments decreases the present value and

increases the future value of an annuity.

Chapter 6: Interest Rates and Bond Valuation

1. When you refer to a bond's coupon, you are referring to which one of the following?

A. Difference between the purchase price and the face value

B. Annual interest divided by the current bond price

C. Difference between the bid and ask price

D. Annual interest payment

E. Principal amount of the bond

2. What is the principal amount of a bond that is repaid at the end of the loan term called?

A. Coupon

B. Market price

C. Accrued price

D. Dirty price

E. Face value

3. The annual interest divided by the face value of a bond is referred to as the:

A. market rate.

B. call rate.

C. coupon rate.

D. current yield.

E. yield-to-maturity.

4. On which one of the following dates is the principal amount of a bond repaid?

A. Coupon date

B. Issue date

C. Discount date

D. Maturity date

E. Face date

5. Which one of the following terms refers to a bond's rate of return that is required by the

market place?

A. Coupon rate

B. Yield to maturity

C. Dirty yield

D. Call yield

E. Discount rate



6. The current yield on a bond is equal to the annual interest divided by which one of the

following?

A. Issue price

B. Maturity value

C. Face amount

D. Current market price

E. Current par value

7. The written agreement that contains the specific details related to a bond issue is called the

bond:

A. indenture.

B. debenture.

C. document.

D. registration statement.

E. issue paper.

8. A registered form bond is defined as a bond that:

A. is a bearer bond.

B. is held in street name.

C. pays coupon payments directly to the owner of record.

D. is listed with the Securities Exchange Commission (SEC).

E. is unsecured.

9. This morning, Jeff found a bond certificate lying on the floor of a bank. He picked it up and

noticed that the bond matured today. He presented the bond to the bank teller and received both

the principal and interest payment. The bond that Jeff found must have been which one of the

following?

A. Debenture

B. Note

C. Registered form bond

D. Bearer form bond

E. Callable bond

10. Miller Farm Products is issuing a 15-year, unsecured bond. Based on this information, you

know that this debt can be described as a:

A. note.

B. bearer form bond.

C. debenture.

D. registered form bond.

E. call protected bond.



Chapter 07: Equity Markets and Stock Valuation

1. What is the name given to the model that computes the present value of a stock by dividing

next year's annual dividend amount by the difference between the discount rate and the rate of

change in the annual dividend amount?

A. Stock pricing model

B. Equity pricing model

C. Capital gain model

D. Dividend growth model

E. Present value model

2. The dividend yield is defined as:

A. the current annual cash dividend divided by the current market price per share.

B. the current annual cash dividend divided by the current book value per share.

C. next year's expected cash dividend divided by the current market price per share.

D. next year's expected cash dividend divided by the current book value per share.

E. next year's expected cash dividend divided by next year's expected market price per share.

3. The capital gains yield equals which one of the following?

A. Total yield

B. Current discount rate

C. Market rate of return

D. Dividend yield

E. Dividend growth rate

4. Which one of the following types of securities has no priority in a bankruptcy proceeding?

A. Convertible bond

B. Senior debt

C. Common stock

D. Preferred stock

E. Straight bond

5. Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board

of directors. Assume there are 3 open seats in the current election and Mary casts all 300 of her

votes for a single candidate. What is the term used to describe this type of voting?

A. Proxy

B. Aggregate

C. Cumulative

D. Straight

E. Condensed

6. There are two open seats on the board of directors. If two separate votes occur to elect the

new directors, the firm is using a type of voting that is best described as _____ voting.

A. simultaneous

B. straight

C. proxy

D. cumulative

E. sequential



7. Kate could not attend the last shareholders meeting and thus she granted the authority to vote

on her behalf to the managers of the firm. Which one of the following terms is used to describe

the method by which Kate's shares were voted?

A. Straight

B. Cumulative

C. Consent-form

D. Proxy

E. In absentia

8. Dividends are best defined as:

A. cash payments to shareholders.

B. cash payments to either bondholders or shareholders.

C. cash or stock payments to shareholders.

D. cash or stock payments to either bondholders or shareholders.

E. distributions of stock to current shareholders.

9. Which one of the following generally pays a fixed dividend, receives first priority in dividend

payment, and maintains the right to a dividend payment, even if that payment is deferred?

A. Cumulative common

B. Noncumulative common

C. Noncumulative preferred

D. Cumulative preferred

E. Senior common

10. Newly issued securities are sold to investors in which one of the following markets?

A. Proxy

B. Stated value

C. Inside

D. Secondary

E. Primary

Chapter 08: Net Present Value and Other Investment Criteria

1. The net present value of an investment represents the difference between the investment's:

A. cash inflows and outflows.

B. cost and its net profit.

C. cost and its market value.

D. cash flows and its profits.

E. assets and liabilities.

2. Discounted cash flow valuation is the process of discounting an investment's:

A. assets.

B. future profits.

C. liabilities.

D. costs.

E. future cash flows.



3. The payback period is the length of time it takes an investment to generate sufficient cash

flows to enable the project to:

A. produce a positive annual cash flow.

B. produce a positive cash flow from assets.

C. offset its fixed expenses.

D. offset its total expenses.

E. recoup its initial cost.

4. The average net income of a project divided by the project's average book value is referred to

as the project's:

A. required return.

B. market rate of return.

C. internal rate of return.

D. average accounting return.

E. discounted rate of return.

5. Which one of the following defines the internal rate of return for a project?

A. Discount rate that creates a zero cash flow from assets

B. Discount rate which results in a zero net present value for the project

C. Discount rate which results in a net present value equal to the project's initial cost

D. Rate of return required by the project's investors

E. The project's current market rate of return

6. The net present value profile illustrates how the net present value of an investment is affected

by which one of the following?

A. Project's initial cost

B. Discount rate

C. Timing of the project's cash inflows

D. Inflation rate

E. Real rate of return

7. The possibility that more than one discount rate can cause the net present value of an

investment to equal zero is referred to as:

A. duplication.

B. the net present value profile.

C. multiple rates of return.

D. the AAR problem.

E. the dual dilemma.

8. Both Projects A and B are acceptable as independent projects. However, the selection of

either one of these projects eliminates the option of selecting the other project. Which one of the

following terms best describes the relationship between Project A and Project B?

A. Mutually exclusive

B. Conventional

C. Multiple choice

D. Dual return

E. Crosswise



9. Which one of the following can be defined as a benefit-cost ratio?

A. Net present value

B. Internal rate of return

C. Profitability index

D. Accounting rate of return

E. Modified internal rate of return

10. Which one of the following indicates that a project is expected to create value for its

owners?

A. Profitability index less than 1.0

B. Payback period greater than the requirement

C. Positive net present value

D. Positive average accounting rate of return

E. Internal rate of return that is less than the requirement

Chapter 09: Making Capital Investment Decisions

1. Any changes to a firm's projected future cash flows that are caused by adding a new project

are referred to as which one of the following?

A. Eroded cash flows

B. Deviated projections

C. Incremental cash flows

D. Directly impacted flows

E. Assumed flows

2. Which one of the following principles refers to the assumption that a project will be evaluated

based on its incremental cash flows?

A. Forecast assumption principle

B. Base assumption principle

C. Fallacy principle

D. Erosion principle

E. Stand-alone principle

3. A cost that should be ignored when evaluating a project because that cost has already been

incurred and cannot be recouped is referred to as which type of cost?

A. Fixed

B. Forgotten

C. Variable

D. Opportunity

E. Sunk

4. Which one of the following terms refers to the best option that was foregone when a

particular investment is selected?

A. Side effect

B. Erosion

C. Sunk cost

D. Opportunity cost

E. Marginal cost



5. Which one of the following terms is most commonly used to describe the cash flows of a new

project that are simply an offset of reduced cash flows for a current project?

A. Opportunity cost

B. Sunk cost

C. Erosion

D. Replicated flows

E. Pirated flows

6. A pro forma financial statement is a financial statement that:

A. expresses all values as a percentage of either total assets or total sales.

B. compares actual results to the budgeted amounts.

C. compares the performance of a firm to its industry.

D. projects future years' operations.

E. values all assets based on their current market values.

7. The amount by which a firm's tax bill is reduced as a result of the depreciation expense is

referred to as the depreciation:

A. tax shield.

B. credit.

C. erosion.

D. opportunity cost.

E. adjustment.

8. Which one of the following refers to a method of increasing the rate at which an asset is

depreciated?

A. Non-cash expense

B. Straight-line depreciation

C. Depreciation tax shield

D. Accelerated cost recovery system

E. Market based depreciation

9. Forecasting risk is best defined as:

A. reality risk.

B. value risk.

C. potential risk.

D. management risk.

E. estimation risk.

10. Jamie is analyzing the estimated net present value of a project under various what if

scenarios. The type of analysis that Jamie is doing is best described as:

A. sensitivity analysis.

B. erosion planning.

C. scenario analysis.

D. benefit planning.

E. opportunity evaluation.

Chapter 10: Some Lessons from Capital Market History



1. Investors require a 4 percent return on risk-free investments. On a particular risky investment,

investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What

is this excess return called?

A. Inflation premium

B. Required return

C. Real return

D. Average return

E. Risk premium

2. The variance is the average squared difference between which of the following?

A. Actual return and average return

B. Actual return and (average return/N - 1)

C. Actual return and the real return

D. Average return and the standard deviation

E. Actual return and the risk-free rate

3. Which one of the following is the positive square root of the variance?

A. Standard deviation

B. Mean

C. Risk-free rate

D. Average return

E. Real return

4. Which one of the following is defined as a bell-shaped frequency distribution that is defined

by its average and its standard deviation?

A. Arithmetic average return

B. Variance

C. Standard deviation

D. Probability curve

E. Normal distribution

5. Which one of the following is defined as the average compound return earned per year over a

multiyear period?

A. Geometric average return

B. Variance of returns

C. Standard deviation of returns

D. Arithmetic average return

E. Normal distribution of returns

6. Which one of the following best describes an arithmetic average return?

A. Total return divided by N - 1, where N equals the number of individual returns

B. Average compound return earned per year over a multiyear period

C. Total compound return divided by the number of individual returns

D. Return earned in an average year over a multiyear period

E. Positive square root of the average compound return



7. An efficient capital market is best defined as a market in which security prices reflect which

one of the following?

A. Current inflation

B. A risk premium

C. Available information

D. The historical arithmetic rate of return

E. The historical geometric rate of return

8. Which one of the following is the hypothesis that securities markets are efficient?

A. Geometric market hypothesis

B. Standard deviation hypothesis

C. Efficient markets hypothesis

D. Capital market hypothesis

E. Financial markets hypothesis

9. Which one of the following combinations will always result in an increased dividend yield?

A. Increase in the stock price combined with a lower dividend amount

B. Increase in the stock price combined with a higher dividend amount

C. Decrease in the stock price combined with a lower dividend amount

D. Decrease in the stock price combined with a higher dividend amount

E. Increase in the stock price combined with a constant dividend amount

10. Which one of the following could cause the total return on an investment to be a negative

rate?

A. Constant annual dividend amount

B. Increase in the annual dividend amount

C. Stock price that remains constant over the investment period

D. Stock price that declines over the investment period

E. Stock price that increases over the investment period

Chapter 11: Risk and Return

1. Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock.

Which one of the following best describes the 16.5 percent rate?

A. Expected return

B. Real return

C. Market rate

D. Systematic return

E. Risk premium

2. Which one of the following best describes a portfolio?

A. Risky security

B. Security equally as risky as the overall market

C. New issue of stock

D. Group of assets held by an investor

E. Investment in a risk-free security



3. Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies

to the 28 percent?

A. Portfolio variance

B. Portfolio standard deviation

C. Portfolio weight

D. Portfolio expected return

E. Portfolio beta

4. Which one of the following describes systemic risk?

A. Risk that affects a large number of assets

B. An individual security's total risk

C. Diversifiable risk

D. Asset specific risk

E. Risk unique to a firm's management

5. Which of the following terms can be used to describe unsystematic risk?

I. asset-specific risk

II. diversifiable risk

III. market risk

IV. unique risk

A. I and IV only

B. II and III only

C. I, II, and IV only

D. II, III, and IV only

E. I, II, III, and IV

6. Which one of the following terms best refers to the practice of investing in a variety of

diverse assets as a means of reducing risk?

A. Systematic

B. Unsystematic

C. Diversification

D. Security market line

E. Capital asset pricing model

7. The systematic risk principle states that the expected return on a risky asset depends only on

which one of the following?

A. Unique risk

B. Diversifiable risk

C. Asset-specific risk

D. Market risk

E. Unsystematic risk

8. Which one of the following measures the amount of systematic risk present in a particular

risky asset relative to that in an average risky asset?

A. Squared deviation

B. Beta coefficient

C. Standard deviation

D. Mean

E. Variance



9. The security market line is a linear function which is graphed by plotting data points based on

the relationship between which two of the following variables?

A. Risk-free rate and beta

B. Market rate of return and beta

C. Market rate of return and the risk-free rate

D. Risk-free rate and the market rate of return

E. Expected return and beta

10. Which one of the following is the slope of the security market line?

A. Risk-free rate

B. Market risk premium

C. Beta coefficient

D. Risk premium on an individual asset

E. Market rate of return

Chapter 12: Cost of Capital

1. Katie owns 100 shares of ABC stock. Which one of the following terms is used to refer to the

return that Katie and the other shareholders require on their investment in ABC?

A. Weighted average cost of capital

B. Pure play cost

C. Cost of equity

D. Subjective cost

E. Cost of debt

2. Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of

return that he and the other lenders require is referred to as the:

A. pure play cost.

B. cost of debt.

C. weighted average cost of capital.

D. subjective cost.

E. cost of equity.



3. The weighted average cost of capital is defined as the weighted average of a firm's:

A. return on its investments.

B. cost of equity and its aftertax cost of debt.

C. pretax cost of debt and equity securities.

D. bond coupon rates.

E. dividend and capital gains yields.

4. Farmer's Supply, Inc. is considering opening a clothing store, which would be a new line of

business for the firm. Management has decided to use the cost of capital of a similar clothing

store as the discount rate that should be used to evaluate this proposed expansion. Which one of

the following terms is used to describe the approach Farmer's Supply is taking to establish an

appropriate discount rate for the project?

A. Equity approach

B. Aftertax approach

C. Subjective approach

D. Market play

E. Pure play approach

5. Kate is the CFO of a major firm and has the job of assigning discount rates to each project

that is under consideration. Kate's method of doing this is to assign an incrementally higher rate

as the risk level of the project increases over that of the current firm. Likewise, she assigns lower

rates as the risk level declines. Which one of the following approaches is Kate using to assign the

discount rates?

A. Pure play approach

B. Divisional rating

C. Subjective approach

D. Straight WACC approach

E. Equity rating

6. Ted is trying to decide what cost of capital he should assign to a project. Which one of the

following should be his primary consideration in this decision?

A. Amount of debt used to finance the project

B. Use, or lack thereof, of preferred stock to finance the project

C. Mix of funds used to finance the project

D. Risk level of the project

E. Length of the project's life

7. Black Stone Furnaces wants to build a new facility. The cost of capital for this investment is

primarily dependent upon which one of the following?

A. Firm's overall source of funds

B. Source of the funds used to build the facility

C. Current tax rate

D. The nature of the investment

E. Firm's historical average rate of return



8. Which one of the following statements is correct related to the dividend growth model

approach to computing the cost of equity?

A. The rate of growth must exceed the required rate of return.

B. The rate of return must be adjusted for taxes.

C. The annual dividend used in the computation must be for year one if you are using today's

stock price to compute the return.

D. The cost of equity is equal to the return on the stock plus the risk-free rate.

E. The cost of equity is equal to the return on the stock multiplied by the stock's beta.

9. A firm has a return on equity of 12.4 percent according to the dividend growth model and a

return of 18.7 percent according to the capital asset pricing model. The market rate of return is

13.5 percent. What rate should the firm use as the cost of equity when computing the firm's

WACC?

A. 12.4 percent because it is lower than 18.7 percent

B. 18.7 percent because it is higher than 12.4 percent

C. The arithmetic average of 12.4 percent and 18.7 percent

D. The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent

E. 13.5 percent

10. Which of the following features are advantages of the dividend growth model?

I. easy to understand

II. model simplicity

III. constant dividend growth rate

IV. model's applicability to all common stocks

A. II only

B. I and III only

C. II and IV only

D. I and II only

E. I, II, and III only

AND MUCH MORE

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Test bank for essentials of corporate finance 7th edition, stephen a. ross

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Transcript of Test bank for essentials of corporate finance 7th edition, stephen a. ross