Deck 18: Stock Equilibrium and Project Evaluation

Question 1

Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

Answer 1

False

Question 2

If markets are in equilibrium, which of the following conditions will exist?

A) Each stock's expected return should equal its realized return as seen by the marginal investor.
B) Each stock's expected return should equal its required return as seen by the marginal investor.
C) All stocks should have the same expected return as seen by the marginal investor.
D) The expected and required returns on stocks and bonds should be equal.
E) All stocks should have the same realized return during the coming year.

Answer 2

B

Question 3

If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Answer 3

True

Question 4

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

A) the expected future return must be less than the most recent past realized return.
B) the past realized return must be equal to the expected return during the same period.
C) the required return must equal the realized return in all periods.
D) the expected return must be equal to both the required future return and the past realized return.
E) the expected future return must be equal to the required return.

Question 5

Which of the following statement completions is NOT CORRECT? For a profitable firm, when MACRS accelerated depreciation is compared to straight-line depreciation, MACRS accelerated allowances produce

A) Higher depreciation charges in the early years of an asset's life.
B) Larger cash flows in the earlier years of an asset's life.
C) Larger total undiscounted profits from the project over the project's life.
D) Smaller accounting profits in the early years, assuming the company uses the same depreciation method for tax and book purposes.
E) Lower tax payments in the earlier years of an asset's life.

Question 6

Other things held constant, which of the following would increase the NPV of a project being considered?

A) A shift from straight-line to MACRS depreciation.
B) Making the initial investment in the first year rather than spreading it over the first three years.
C) An increase in the discount rate associated with the project.
D) An increase in required net operating working capital.
E) The project would decrease sales of another product line.

Question 7

If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

Question 8

For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.