I want to discuss the answers in class with some explanations.
True or False with an explanation
Problem 1. An increase in interest rates will cause the current resale value of a long term bond to increase more than that of a short term bond.
Problem 2. In the CAPM, Beta can best be described as the relative volatility of a security as compared to the total stock market with a Beta of 1 indicating that the stock is equally as volatile as the markets are as a whole.
Problem 3. Most companies will use the lowest interest rate of their long term debt as the discount rate (hurdle rate) for doing the NPV calculations on capital projects.
Problem 4. The Present Value (PV) of $10,000 received 3 years from now assuming an interest rate of 4.5% would be $11,411.66.
Problem 5. If two capital projects are mutually exclusive you should always select the one with the highest IRR and ignore the NPV of each project.
Problem 6. One of the major advantages of funding the company with debt financing is the tax effects realized because the interest charges are a tax deduction.
Problem 7. When it comes to paying dividends, a large mature slow-growing company is much more likely to pay out a dividend than is a new fast-growing start up company.
Problem 8. If you were to graph the WACC you would find that increasing the amount of debt will lower the WACC to a point and then it will start to rise again as debt increases further. This results in a U shaped curve on the graph.
Problem 9. A company that is underleveraged (too little debt) can be considered a more attractive take over target simply because of this fact.
Problem 10. The Pay Back Method is preferred by many companies because it is relatively easy to use and incorporates Time Value of Money concepts.