finance final

C. prices of both falls, but price of A falls more than B

2 bonds each have par value of $1000 and coupon rate of 10%. Investors require a return of 10% on both bonds. Bond A= 12 years until maturity Bond B= 5 years until maturity A. prices of both go up, but Bond A rises more B. prices of both dow up, but Bond B rises more C. prices of both falls, but price of A falls more than B D. prices of both falls, but price of B falls more than B E. prices fall in same way

A perpetual bond is similar to a no-growth stock and to a share of perpetual preferred stock in the following ways: 1. All three derive their values from a series of cash inflows—coupon payments from the perpetual bond and dividends from both types of stock. 2. All three are assumed to have indefinite lives with no maturity value (M) for the perpetual bond and no capital gains yield for the stocks. However, there are preferred that have a stated maturity. In this situation, the preferred would be valued much like a bond with a stated maturity. Both derive their values from a series of cash inflows—coupon payments and a maturity value for the bond and dividends and a stock price for the preferred.

A bond that pays interest forever and has no maturity is a perpetual bond. In what respect is a perpetual bond similar to a no-growth common stock? Are there preferred stocks that are evaluated similarly to perpetual bonds and other preferred issues that are more like bonds with finite lives? Explain.

The first question is related to Question 11-3 and the same rationale applies. A high cost of capital favors a shorter-term project. If the cost of capital declined, it would lead firms to invest more in long-term projects. With regard to the last question, the answer is no; the IRR rankings are constant and independent of the firm's cost of capital.

If two mutually exclusive projects were being compared, would a high cost of capital favor the longer-term or the shorter-term project? Why? If the cost of capital declined, would that lead firms to invest more in longer-term projects or shorter-term projects? Would a decline (or an increase) in the WACC cause changes in the IRR ranking of mutually exclusive projects? Explain.

Yes. If a company decides to increase its payout ratio, then the dividend yield component will rise, but the expected long-term capital gains yield will decline.

If you bought a share of common stock, you would probably expect to receive dividends plus an eventual capital gain. Would the distribution between the dividend yield and the capital gains yield be influenced by the firm's decision to pay more dividends rather than to retain and reinvest more of its earnings? Explain.

D. risk-averse

In finance, we typically assume average investor is: A. risk-seeking B. risk-neutral C. risk-indifferent D. risk-averse

C. Port X = 0.35 Port. Y > 0.35

Portfolio X consists of equal amounts of two securities (50-50 mix), each which has st. dev =0.35. Correlation coefficient between the two securities in Portfolio X = 1.00. Portfolio Y consists of equal amounts of two securities (50-50 mix), each which has st. dev=0.35. Correlation coefficient between the two securities in Port. Y = 0.65 A. each has st. dev of returns = 0.35 B. each has st. dev of returns > 0.35 C. Port X = 0.35 Port. Y > 0.35 D. Port X > 0.35 Port Y = 0.35

In general, failing to adjust for differences in risk would lead the firm to accept too many risky projects and reject too many safe ones. Over time, the firm would become more risky, its WACC would increase, and shareholder value would suffer.The cost of capital for average-risk projects would be the firm's cost of capital, 10%. A somewhat higher cost would be used for more risky projects, and a lower cost would be used for less risky ones. For example, we might use 12% for more risky projects and 9% for less risky projects. These choices are arbitrary.

Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be "reasonable" costs of capital for average-, high-, and low-risk projects?

payback period

The length of time required for an investment's cash flows to cover its cost.

discounted payback

The length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost.

Yes.The value of a share of stock is the PV of its expected future dividends.If the two investors expect the same future dividend stream, and they agree on the stock's riskiness, then they should reach similar conclusions as to the stock's value. The difference in their holding periods doesn't matter.

Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of and on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the basis of the type of analysis done in this chapter, should they both be willing to pay the same price for GE's stock? Explain.

capital market and primary

Verizon issues $10 million in new stock. Is it money market capital market transaction? Primary or secondary transaction?

The regular payback method has three main flaws: (1) Dollars received in different years are all given the same weight. (2) Cash flows beyond the payback year are given no consideration whatever, regardless of how large they might be. (3) Unlike the NPV, which tells us by how much the project should increase shareholder wealth, and the IRR, which tells us how much a project yields over the cost of capital, the payback merely tells us when we recover our investment. The discounted payback corrects the first flaw, but the other two flaws still remain.

What are three potential flaws with the regular payback method? Does the discounted payback method correct all three flaws? Explain.

Mutually exclusive projects are a set of projects in which only one of the projects can be accepted. For example, the installation of a conveyor-belt system in a warehouse and the purchase of a fleet of forklifts for the same warehouse would be mutually exclusive projects—accepting one implies rejection of the other. When choosing between mutually exclusive projects, managers should rank the projects based on the NPV decision rule. The mutually exclusive project with the highest positive NPV should be chosen. The NPV decision rule properly ranks the projects because it assumes the appropriate reinvestment rate is the cost of capital.

What is a mutually exclusive project? How should managers rank mutually exclusive projects?

The NPV method assumes reinvestment at the cost of capital, while the IRR method assumes reinvestment at the IRR. MIRR is a modified version of IRR that assumes reinvestment at the cost of capital.

What reinvestment rate assumptions are built into the NPV, IRR, and MIRR methods? Give an explanation for your answer.

The NPV is obtained by discounting future cash flows, and the discounting process actually compounds the interest rate over time. Thus, an increase in the discount rate has a much greater impact on a cash flow in Year 5 than on a cash flow in Year 1.

Why is the NPV of a relatively long-term project (one for which a high percentage of its cash flows occurs in the distant future) more sensitive to changes in the WACC than that of a short-term project?

B. Depreciation and other noncash charges

each of the following considered use of cash except: A. repurchase/retirement of stock B. depreciation and other noncash charges C. decrease in any liability D. increase in any asset

B. paying interest on bonds rather than dividends on stock and receiving dividends on stock rather than on bonds

from tax standpoint; is a corporation better off: A. paying dividends on stock rather than interest on bonds, and receiving interest on bonds rather than dividends on stock B. paying interest on bonds rather than dividends on stock and receiving dividends on stock rather than on bonds

E. B and C (both are sweeteners to make bond more appealing)

if this bond feature is present, issuer can offer a lower yield to maturity than would otherwise be necessary A. Call feature B. Conversion feature C. Stock Purchase warrant D. A and B E. B and C

maximize shareholder wealth

what is the primary goal of a corporate financial manager

D. too short, investment rate risk

you want to make a down payment on a house 8 years from today. The $ you have set aside for this down payment is invested in bond portfolio, the duration of the portfolio is 4.5 years. Which statement is accurate: A. too long, result in price risk B. too long, result in reinvestment rate risk C. too short, price risk D. too short, investment rate risk