FIN 302- Exam #2 Old 2

FIN 302- Exam #2 Old 2 - Exam II (30 questions + 1 extra...

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Exam II (30 questions + 1 extra credit question) 1)______ Which of the following encourages the acceptance of high-risk projects? a) Managers hold high levels of stock in their own firms b) Managers have high levels of compensation not contingent upon firm performance c) There is little difference between the compensation levels of VP’s and the compensation of top level managers (the CEO & president). d) A large proportion of CEO compensation consists of stock options. e) Exactly two of the above are correct The value of the stock options increases as risk increases. (The return distribution is skewed right. The more risk, the fatter the right hand tail of the distribution, meaning a greater chance of a very high return.) Choices a and b discourage risk. Choice “c” may have no effect on risk taking (or might actually discourage risk taking, as there is little reward for successes.) 2)______ Which of the following would result in lower agency costs for the firm? a) A decline in the firm’s debt ratio (debt/total assets) b) A firm funds new projects using retained earnings, instead of underwritten stock issues. c) The sale of a 5% block of stock by an unaffiliated outside blockholder to many small outside stockholders d) A strict outside director is replace by a Bank CEO e) In fact, none of the above would decrease a firm’s agency costs All of the above changes increase agency costs. 3)_____ The Economic Value Added (EVA) for a project of average risk can best be defined as: a) The project’s internal rate of return b) The project’s internal rate of return less the project’s minimally acceptable required rate of return. c) The NPV of the project divided by the project’s standard deviation of cash flows d) The project’s coefficient of variation e) The NPV of project less the cost of the project. 4) ______ Which of the following is true? a) Firms that are recognized as having high quality managers will generally earn a higher rate of return for stockholders. b) All else equal, and older firm will have a lower ROA (NI/Book assets) c) All else equal, a firm with more debt will have a lower ROE (NI/Book equity) d) A firm with a higher Market/Book ratio of equity will have fewer growth opportunities (i.e., fewer positive NPV projects) e) In fact, none of the above statements is true Choice “a” is untrue – the stock price will be adjusted such that investors will earn returns that 1
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(on average) compensate them for risk. So high quality firms producing high cash flows for shareholders will have higher stock prices (so that returns do not differ, necessarily, from those of low-quality firms.) A younger firm will tend to have a lower ROA (because book assets will be relatively higher from that of an older firm). A firm with more debt will have a higher ROE (more risk – more variability in earnings that accrue to equity holders). A high book / market ratio firm has MORE growth opportunities.
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This note was uploaded on 11/15/2011 for the course FIN 302 taught by Professor Kellybrunarski during the Spring '11 term at Miami University.

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FIN 302- Exam #2 Old 2 - Exam II (30 questions + 1 extra...

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