Foundations of Financial Management, 17e (Block)
Chapter 10 Valuation and Rates of Return
1) The valuation of a financial asset is based on the concept of determining the present value of
future cash flows that this financial asset will accumulate.
2) The prices of financial assets are based on the expected value of future cash flows, the
discount rate, and past dividends.
3) The market-determined required rate of return is the appropriate discount rate used in
valuation calculations.
4) The discount rate depends on the market’s perceived level of risk associated with an individual
security.
5) By using different discount rates, the market allocates capital to companies based on their risk,
efficiency, and expected returns.
6) In estimating the market value of a bond, the coupon rate should be used as the discount rate.
7) Most bonds promise both a periodic return and a lump-sum payment.
8) A 10-year bond pays 6% annual interest in semiannual payments. The current market yield to
maturity is 4%. The appropriate interest factors used to calculate the sales price of this bond
should be in the TVM tables under 2% for 20 periods.
9) The price of a bond is equal to the present value of all future interest payments added to the
present value of the principal.
10) The coupon rate is used to calculate the bond’s interest amount, while the yield is used to
calculate the present value of both the interest amount and principal amount of the bond.
11) When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par
value or equal to its principal amount.
12) An increase in the yield of a bond compared to the coupon rate would be associated with an
increase in the price of a bond.
13) You hold a long-term bond yielding 10%. If interest rates fall before you sell the bond, you
will sell at a higher price than if interest rates had been constant.
14) When a bond trades at a discount to par, the yield to maturity on the bond will exceed the
required return.
15) The yield to maturity is always equal to the coupon rate of a bond.
16) The appropriate discount rate for the valuation of bonds is called the yield to maturity.
17) The required rate of return is the rate of return the investor demands for giving up the current
use of the funds on a noninflation-adjusted basis.
18) The coupon rate of bonds is equal to the stated rate on the bond’s contract.
19) The total required rate of return is equal to the real rate of return plus the inflation premium.
20) The yield to maturity is also known as the discount rate and is the rate of return required by
bondholders.
21) Historically, the real rate of return has been about 2% to 3%.
22) The required rate of return is the payment demanded by the investors for foregoing their
ability to use the funds themselves.
23) The inflation premium is based on past and current inflation levels.
24) The “risk-free rate of return” is equal to the inflation premium plus the real rate of return.
25) The risk premium is equal to the required yield to maturity (or rate of return) minus both the
real rate of return and the inflation premium.
26) The “risk premium” is primarily concerned with business risk, financial risk, and inflation
risk.
27) “Business risk” relates to the inability of the firm to meet its debt obligations as they come
due.
28) Risk premiums are higher for riskier securities, but the risk premium cannot be higher than
the required rate of return.
29) High-risk corporate bonds are referred to as junk bonds.
30) There is a negative correlation between risk and the return investors demand.
31) When inflation rises, bond sales prices fall.
32) An increase in inflation will cause a bond’s required return to rise.
33) The higher the yield to maturity on a bond, the closer to par the bond will trade.
34) The closer the yield to maturity on a bond to the stated rate, the closer to par the bond will
trade.
35) The longer the maturity of a bond, the greater the impact on price to changes in market
interest rates.
36) As time to maturity increases, bond price sensitivity decreases.
37) The further the yield to maturity of a bond moves away from the bond’s coupon rate, the
greater the price-change effect will be.
38) The price of preferred stock is determined by dividing the fixed dividend payment by the
required rate of return.
39) Preferred stock may not have the same ownership privileges as common stock, but preferred
stock offers a fixed dividend stream supported by a binding contractual obligation.
40) Preferred stock would be valued the same as a common stock with a zero dividend growth
rate.
41) When inflation rises, preferred stock prices fall.
42) The variable growth model is most useful for firms in emerging industries.
43) The value of a share of stock is the present value of the expected stream of future dividends.
44) Valuation of a common stock with no dividend growth potential is treated in the same
manner as preferred stock.
45) The risk premium relates to the inability of the firm to hold its competitive position and
maintain stability and growth in earnings.
46) The constant dividend growth valuation formula is P0 = D1/(Ke – g).
47) The variable growth dividend model can be used for both constant and variable growth
stocks.
48) To use a dividend valuation model, a firm must have a constant growth rate, and the discount
rate must not exceed the growth rate.
49) The drawback of the future stock value procedure is that it does not consider dividend
income.
50) Future stock value is equal to P0 = D1/(Ke – g), assuming a constant growth in dividends.
51) Firms with an expectation for great potential tend to trade at low P/E ratios.
52) The price-earnings ratio is another tool used to measure the value of common stock.
53) Firms with high expectations for the future tend to trade at high P/E ratios.
54) A stock that has a high required rate of return because of its risky nature will usually have a
high P/E ratio.
55) The fact that small businesses are usually illiquid does not affect their valuation process.
56) Even though the IRS tries to minimize occurrences, small business owners often intermingle
business and personal expenses in order to minimize taxable income.
57) Valuation of financial assets requires knowledge of
A) company valuation.
B) an appropriate discount rate.
C) past asset performance.
D) future cash flows and an appropriate discount rate.
58) The market allocates capital to companies based on
A) risk.
B) efficiency.
C) expected returns.
D) all of these options are true.
59) In a general sense, the value of any asset is the
A) value of the dividends received from the asset.
B) present value of the cash flows expected to be received from the asset.
C) value of past dividends and price increases for the asset.
D) future value of the expected earnings discounted by the asset’s cost of capital.
60) Which of the following financial assets is likely to have the highest required rate of return
based on risk?
A) Corporate bond
B) U.S. Treasury bill
C) Certificate of deposit
D) Common stock
61) A bond that has a “yield to maturity” greater than its coupon interest rate will sell for a price
A) below par.
B) at par.
C) above par.
D) that is equal to the face value of the bond plus the value of all interest payments.
62) Which of the following is not one of the components included in the required rate of return
on a bond?
A) Risk premium
B) Real rate of return
C) Inflation premium
D) Market yield
63) A 20-year bond pays 6% annually on a face value of $1,000. If similar bonds are currently
yielding 4%, what is the market value of the bond? Use time value of money tables in Appendix
B and Appendix D.
A) $1,271.40
B) $573.50
C) $770.80
D) Not enough information is given to tell.
64) A 10-year bond, with a par value equaling $1,000, pays 7% annually. If similar bonds are
currently yielding 6% annually, what is the market value of the bond? Use semiannual analysis.
Use time value of money tables in Appendix B and Appendix D.
A) $700.00
B) $927.50
C) $1,074.70
D) $1,520.70