FINANCE 634 EXAM 2Fall 2002N OTE W ELL:For problems: You must show enough work to justify your answer in the space provided with each problem. No credit will be given unless work is shown. Partial credit may be given ONLY IF your work is clearly labeled. Be sure to read all questions carefully and answer them completely. Do all work on this test booklet. Points are as marked.Points sum to 100 exclusive of extra credit.Note that later questions tend to carry more points.The penalty for academic dishonesty in this course is an “F” grade for the course and the immediate commencement of due process proceedings for permanent dismissal from The University of Mississippi. There are no lesser penalties and no exceptions.Name: ________________________________Multiple Choice: Select the one best answer for each question and mark your choice on yout Scan-Tron answer sheet. 1 point per correct answer. 1. The expected return on an investment is:a. Just another way of saying “required return”. They mean the same thing.b. Greater than the required return if the investment has a positive NPV. c. Less than the required return if the investment has a positive NPV.d. More than one of the above.e. None of the above.2. If the values of two investments have a correlation coefficient with each other of zero, then:a. It must be true that there is no variability in the value of at least one of the assetsb. It must be true that there is no variability in the values of both assetsc. It must be true that the expected value of at least one of the assets is zerod. More than one of the abovee. None of the above 3. Which of the following items represents an incremental cash flow?a. A shut-down (terminal) cash flow for the project b. Overhead (fixed) expenses for the companyc. R&D costs that were invested over the last yeard. Two of the abovee. All of the above4. Which of the following is(are) characteristic(s) of a well-diversified portfolio?a. Total risk equals zerob. Unsystematic risk equals zeroc. Total risk equals systematic riskd. A and Be. C and B 5. The Capital Asset Pricing Model, as represented by the Security Market Line, showsa. The minimum expected return that investors should require as compensation for the non-diversifiable risk they bear by owning an assetb. That owning stocks with higher systematic risk will always produce higher returnsc. The cost of equity for a company’s stock given the ß for the stockd. Two of the above e. All of the above6. Changes in the cost of equity capital for a company are related to changes in each of the following factors EXCEPT:a. Investors’ expectations concerning inflationb. The amount of debt the company usesc. The riskfree rate of interestd. The sensitivity of the company’s stock price to changes in the prices of other stockse. None of the above are exceptions 7. In any given time period, if Security X is perceived by investors as having greater non-diversifiable risk than Security X, then according to the Capital Asset Pricing Model:a. X’s actual rate of return will always be greater than Y’sb. X’s required rate of return will always be greater than Y’sc. X and Y could have the same actual rate of returnd. A and B are both correcte. B and C are both correct 8. According to the Capital Asset Pricing Model and portfolio theory, which of the following conditions is sufficient by itself to guarantee that two risky securities will have identical dollar prices in the market?a. They have the same Beta coefficientsb. They have the same expected rates of returnc. They have the same required rates of returnd. Both assets’ prices are consistent with the conditions reflected in the Security Market Linee. None of the above. 9. Everything else held constant, which of the following events should decrease a company’s weighted average cost of capital?a. An increase in the expected rate of inflationb. An increase in the general level of demand for corporate securities of all types c. A decrease in the market price of the company’s bondsd. More than one of the abovee. None of the aboveTrue/False: Mark whether each statement is true or false on your Scan-Tron answer sheet.1 Point per correct answer.10. The larger the annual depreciation associated with a project, the larger will be the annual incremental cash flow, other things equal. 11. A good indicator of an investor’s risk exposure if he or she holds a single asset is the expected value of the asset’s returns. 12. The standard deviation is a numerical indicator of how possible values are distributed around the mean. 13. A stock that has a ß of 1.20 will tend to have a larger price movement (in percentage change) in reaction to a surprise announcement about its quarterly earnings than would an average-risk company. 14. All else equal, an increase in the Debt/Equity ratio for a company will increase its systematic risk. 15. The Internal Rate of Return (IRR) is the discount rate that makes the required return on an investment equal to zero. 16. The MIRR for an investment will always be less that its IRR as long as there is only one IRR for the investment. 17. All projects that have an expected return that is less than the firm’s cost of capital should be rejected.18. The larger the annual depreciation associated with a project, the larger will be the annual incremental cash flow, other things equal. 19. The required rate of return on any corporate security will always exceed the riskfree rate if there is a possibility that the actual rate of return on the security will not equal the expected rate of return. 20. As the risk aversion of the average investor in the market increases, the cost of capital for all companies will increase – other things equal. 21. Retained earnings (capital generated by reinvesting earnings) have the lowest cost of capital of all capital sources for a company since the funds were generated from the operations of thecompany and no new securities had to be issued. 22. Diversification eliminates the impact of the risk of any single stock in a portfolio. 23. If the correlation between the rates of return for two securities is zero, then you could compose a portfolio of these two securities that would eliminate ALL risk from the portfolio.24. A major difference between systematic and unsystematic risk is that unsystematic risk is caused primarily by unexpected events while systematic risk is primarily caused by expected