Essay Net Present Value and Answer Rationale

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Topic: Apply valuation techniques to determine the intrinsic value of debt and equity instruments. Question: Assume that the par value of a bond is $1,000. Consider a bond where the coupon rate is 9% and the current yield is 10%. Which of the following statements is true? Answer Rationale: The current yield is typically equal to the coupon rate when the bond is first issued. If the current yield is greater than the coupon rate, the par value of the bond is greater than the market value. |
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Apply valuation techniques to determine the intrinsic value of debt and equity instruments. Question: If the yield to maturity for a bond is less than the bond's coupon rate, the market value of the bond is __________. Answer Rationale: The yield to maturity of a bond and the bond’s market value has an inverse relationship. If the yield to maturity decreases, that means that the market value has increased. |
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Analyze how markets adjust for risk. Question: For investors, the proper measure of a stock's risk is its __________. Answer Rationale: Specific and nonsystematic risk deal with specific instances of something happening and standard deviation measures variance. |
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Analyze how markets adjust for risk. Question: A company’s beta is -1.5. If the overall stock market decreases by 5%, what is the expected change in the firm's stock price? Answer Rationale: Beta is a measure of volatility. The higher the beta, the more volatile the stock. A negative beta means the stock is volatile up when the market is down. |
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Apply the capital-asset pricing model to calculate a business’s required return. Question: Dimensions of risk include __________. Answer Rationale: If an outcome is certain, impossible, or happened yesterday, there is no risk involved. Risk cannot be eliminated completely; it can only be mitigated, which is why any future outcome is uncertain. |
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Apply the capital-asset pricing model to calculate a business’s required return. Question: One problem with using negative values for the proportion invested in the riskless asset to represent a borrowed amount is that the implied borrowing rate of interest is the same as the __________. Answer Rationale: The prime, current, and nominal rates are not associated with a riskless asset. |
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Apply the capital-asset pricing model to calculate a business’s required return. Question: If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be logical to invest in Answer Rationale: Beta is a measure of volatility. The higher the beta, the more volatile the stock. Low beta stocks, stocks with large amounts of unique risk, and stocks that plot below the security market line will not likely provide the best return when the market is increasing on a sustained basis. |
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Calculate the cost of capital. Question: An investor’s risky portfolio is made up of individual stocks. Which of the following statements about this portfolio is true? Answer Rationale: Selling a low beta stock can increase the beta of a portfolio. Stocks can have a beta less than 1. Personal leverage has no relation to portfolio risk. |
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Calculate the cost of capital. Question: If a firm wants to lower its weighted average cost of capital (WACC), one way to do so would be to Answer Rationale: Bonds are usually a cheaper source of capital than stock. One reason is that interest on bonds is tax-deductible, but dividends on stock are taxed twice. Selling common shares, paying a cash dividend, and issuing a stock dividend would tend to increase WACC. |
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Analyze a capital project’s present value based on expected future net cash flows. Question: In practice, the __________ rule is the preferred criteria to accept or reject a capital investment project. Answer Rationale: In analyzing investments, people prefer talking about rates of return rather than dollar values, years, or an index number. |
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