Deck 3: Conservation of Value and the Role of Risk

Question 1

Which of the following most accurately describes the conclusion of Franco Modigliani and Merton Miller as it relates to the conservation of value principle?

A)Managers can create value by adjusting the capital structure of a firm,which is congruous with the conservation of value principle.
B)Managers cannot create value by adjusting the capital structure of a firm,which is congruous with the conservation of value principle.
C)Managers can create value by adjusting the capital structure of a firm,which is a violation of the conservation of value principle.
D)Managers cannot create value by adjusting the capital structure of a firm,which is a violation of the conservation of value principle.

Answer 1

B

Question 2

Investors demand returns for nondiversifiable risks only.

Answer 2

True

Question 3

Managers should hedge risks in their core business,as this helps eliminate some risk to investors without any reduction in returns.

Answer 3

False

Question 4

Firms should engage in share repurchases only if they do not have available investments with sufficiently high ROIC.

Question 5

Financial engineering includes the use of derivatives,structured debt,securitization,and off-balance-sheet financing.In some cases financial engineering can create value.

Question 6

Diversifiable or firm-specific risks,such as the ability to retain talented management and rising input costs,affect a company's cost of capital.

Question 7

The conservation of value principle states that anything that does not increase cash flows does not increase value.

Question 8

Because interest expense is tax deductible,share repurchases can have the beneficial effect of increasing earnings per share,which will definitely lead to a share price increase.

Question 9

The primary way that financial engineering can create value is by lowering firm taxes.

Question 10

If one uses free cash flows to value a firm,then value may be created through a lower cost of capital.

Question 11

Changes in accounting techniques that decrease reported profits will necessarily decrease the value of a firm.

Question 12

There are no exceptions to the principle of conservation of value.

Question 13

Which of the following is true concerning the practice of repurchasing shares when the managers correctly determine that the price of the stock is low?

A)The practice does not benefit either the stockholders who do not sell or those who do sell.
B)The practice benefits the stockholders who do sell more than those who do not sell.
C)The practice benefits stockholders who do not sell and those who do sell equally.
D)The practice benefits the stockholders who do not sell more than those who do sell.

Question 14

Since diversifiable risks are not priced into the cost of capital,executives can ignore such risks.

Question 15

A company cannot create value through sale-leaseback transactions.

Question 16

Risk enters valuation both through a company's cost of capital and through its cash flows.

Question 17

Managers should hedge cash flow risk whenever possible.

Question 18

Multiple expansion is one way that firms can create value through acquisitions.

Question 19

Which of the following is NOT true concerning application of the conservation of value principle to acquisitions?

A)An acquisition will create value if it increases cash flows sufficiently by reducing costs.
B)An acquisition will create value if it increases cash flows sufficiently by increasing revenue growth.
C)An acquisition will create value if it increases cash flows sufficiently by improving the use of fixed or working capital.
D)An acquisition will create value if it grows revenues.

Question 20

Studies of share repurchases have shown that companies are very good at timing share repurchases.