C214 Financial Management Practice Questions - Set 1 - Part 2

Correct Answer: Treasury yields

A bond’s required yield is affected by treasury yields, as bonds trade at a spread over treasury bonds, among other factors like credit risk and term.

Correct Answer: The return that both shareholders and debt holders can expect

WACC represents the average return required by both equity holders and debt holders, accounting for the firm's cost of financing its operations.

Correct Answer: Reduces it

Diversification reduces idiosyncratic risk by spreading investments across various assets, but it does not eliminate systematic risk.

Correct Answer: The extent to which stock prices reflect all available information

Market efficiency indicates how well stock prices incorporate all relevant information, making it difficult to outperform the market consistently.

Correct Answer: Preferred stock

Preferred stock is considered a hybrid security because it has characteristics of both debt (fixed dividends) and equity (ownership without voting rights).

Correct Answer: To decide what assets to purchase

Capital budgeting involves making long-term investment decisions, particularly deciding what assets the firm should invest in for future growth.

Correct Answer: The cost of starting a project

The initial outlay refers to the total cost of starting a project, including purchasing equipment, installation, and initial working capital requirements.

Correct Answer: The rate of return where the net present value equals zero

IRR is the discount rate that makes the net present value of a project zero, indicating the expected rate of growth for an investment.

Correct Answer: Whether to accept or reject an investment project

The NPV method evaluates the profitability of an investment project by comparing cash inflows and outflows. Positive NPV indicates acceptance, while negative NPV suggests rejection.

Correct Answer: It will increase

A positive NPV indicates that the project will add value to the company, which in turn can lead to an increase in the company’s stock price.

Correct Answer: Initial cash outflows and differential cash flows

When calculating IRR, both initial cash outflows and differential (annual) cash flows are considered to determine the project’s profitability.

Correct Answer: Purchasing equipment

Purchasing equipment is considered an investing activity because it involves spending cash on long-term assets for future use.

Correct Answer: Borrowing money and repaying it

Financing activities include transactions involving a company's equity and debt, such as issuing stock, repaying loans, or paying dividends.

Correct Answer: The current ratio includes inventory

The current ratio includes all current assets, whereas the quick ratio excludes inventory to provide a more stringent test of a firm’s short-term liquidity.

Correct Answer: Current ratio

The current ratio measures a firm’s short-term liquidity by comparing its current assets to its current liabilities, indicating its ability to pay short-term obligations.

Correct Answer: Market-wide risk that affects all stocks

Systematic risk refers to risk that impacts the entire market and cannot be eliminated through diversification, such as recessions or changes in interest rates.

Correct Answer: Risk unique to a specific company

Unsystematic risk is specific to an individual company or industry and can be reduced or eliminated through diversification.

Correct Answer: It increases

A downgrade in credit rating signals higher risk, which leads to an increase in the firm’s cost of capital as lenders demand higher returns to compensate for the risk.

Correct Answer: Buy

When the market price is lower than the intrinsic value, the stock is undervalued, so it is typically a good opportunity to buy.

Correct Answer: Risk

The CAPM model incorporates risk into its calculation by using the stock’s beta value, whereas the Gordon Growth Model only considers dividend growth.