1) The cost of equity raised by retaining earnings can be less than, equal to, or greater
than the cost of external equity raised by selling new issues of common stock,
depending on tax rates, flotation costs, the attitude of investors, and other factors.
2) Preferred stock is a hybrida sort of cross between a common stock and a bondin the
sense that it pays dividends that normally increase annually like a stock but its
payments are contractually guaranteed like interest on a bond.
3) Because political risk is seldom negotiable, it cannot be explicitly addressed in
multinational corporate financial analysis.
4) A Eurodollar is a U.S. dollar deposited in a bank outside the United States.
5) A promissory note is the document signed when a bank loan is executed, and it
specifies financial aspects of the loan.
6) A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years
to maturity, cannot be called, and is not expected to default. The bond should sell at a
premium if interest rates are below 10% and at a discount if interest rates are greater
than 10%.
7) Accelerated depreciation has an advantage for profitable firms in that it moves some
cash flows forward, thus increasing their present value. On the other hand, using
accelerated depreciation generally lowers the reported current year’s profits because of
the higher depreciation expenses. However, the reported profits problem can be solved
by using different depreciation methods for tax and stockholder reporting purposes.
8) If a firm with a positive net worth is operating its fixed assets at full capacity, if its
dividend payout ratio is 100%, and if it wants to hold all financial ratios constant, then
for any positive growth rate in sales, it will require external financing.
9) One problem with ratio analysis is that relationships can be manipulated. For
example, we know that if our current ratio is less than 1.0, then using some of our cash
to pay off some of our current liabilities would cause the current ratio to increase and
thus make the firm look stronger.
10) “Risk aversion” implies that investors require higher expected returns on riskier
than on less risky securities.