1) The prices of high-coupon bonds tend to be less sensitive to a given change in
interest rates than low-coupon bonds, other things held constant.
2) Firms raise capital at the total corporate level by retaining earnings and by obtaining
funds in the capital markets. They then provide funds to their different divisions for
investment in capital projects. The divisions may vary in risk, and the projects within
the divisions may also vary in risk. Therefore, it is conceptually correct to use different
risk-adjusted costs of capital for different capital budgeting projects.
3) A call provision gives bondholders the right to demand, or “call for,” repayment of a
bond. Typically, calls are exercised if interest rates rise, because when rates rise the
bondholder can get the principal amount back and reinvest it elsewhere at higher rates.
4) 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.
5) The CAPM is built on historic conditions, although in most cases we use expected
future data in applying it. Because betas used in the CAPM are calculated using
expected future data, they are not subject to changes in future volatility. This is one of
the strengths of the CAPM.
6) According to the basic DCF stock valuation model, the value an investor should
assign to a share of stock is dependent on the length of time he or she plans to hold the
stock.
7) A firm should never accept a project if its acceptance would lead to an increase in the
firm’s cost of capital (its WACC).
8) The disadvantages associated with a proprietorship are similar to those under a
partnership. One exception relates to the more formal nature of the partnership
agreement and the commitment of all partners’ personal assets. As a result, partnerships
do not have difficulty raising large amounts of capital.
9) Dimon Products’ sales are expected to be $5 million this year, with 90% on credit
and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in
the future. Dimon’s accounts receivable balance will remain constant at the current
level, because the 10% cash sales can be used to support the 10% growth rate, other
things held constant.
10) Typically, a project will have a higher NPV if the firm uses accelerated rather than
straight-line depreciation. This is because the total cash flows over the project’s life will
be higher if accelerated depreciation is used, other things held constant.