Fin Test 3: Non Quan Flashcards
(37 cards)
Relationship between interest rates and bonds
When interest rates rise, prices of existing bonds tend to fall
-inverse relationship (one goes up, while other goes down)
Bonds selling at par, premium, or discount
-Par Bond: currently trades at its face value
-Premium Bond: trading above it face value or costs more than the face amount on the bond
-Discount Bond: a bond that is issued for less than its par- or face- value
Value
-equals to present value of future CFs
Weight component costs of capital (WACC) according to optimal capital structure
carrying effects on the market capitalization rates for debt and equity allow the firm to lowers its cost of capital by the use of leverage (debt)
Why can’t debt financing be used to provide all the capital of the firm?
Equity Increases
Relationship between use of debt and type of industry
D/E ratios vary across industries because some industries are more capital intensive than others.
Why is firm’s cost of debt lower than the yield on its bonds?
in bankruptcy, bondholders are paid before shareholders as the firm’s assets are liquidated.
What does a firm’s Beta in CAPM measure?
systematic risk and expected ROA
Yield-to-maturity on bonds
-equals to firm’s pre-tax cost of debt
Why is cost of new common stock higher than the cost of retained earnings?
floation costs and common stock is risker
What are capital budgeting decision rules for IRR and NPV?
project should be pursued if IRR is greater than the min required rate of return
What relationship does the Security Market Line in CAPM show?
the different levels of risk and marketable securities
What is relationship between bond price and yield-to-maturity?
-inverse
-bond price ^ yield -^
Define the CAPM model
describes the relationship between systematic risk and expected return on assets
What does a Beta of less than, equal to, or greater than 1 mean?
= 1, means security price tends to move with the market
> means security price tends to be more volatile
< means security price tends to be less volatile
What are the IRR and NPV reinvestment rate assumptions?
IRR has no reinvestment rate assumptions; meaning the reinvestment rate will not change the outcome of the project
NPV- the company will reinvest cash inflows at the IRRs rate of return for the lifetime of the project
If an investment has a positive, 0, or negative NPV, for each case relate IRR to the cost
of capital.
0= IRR= Discount rate
NPV (-) IRR is below discount rate
NPV(+) IRR above discount rate
What are the weaknesses and strengths of the Payback method?
weakness- ignores TVM, and cash flows after the payback period
strengths- easy to do and compare to other projects gives cash payback period as well
What doe and NPV profile show?
graph that shows the discount rate and the npv of the investment
Why is NPV more conservative than the IRR in selecting investment projects?
assumes that cash flows are reinvested at the firms weighted avg. cost of capital
What does “risk averse” mean?
when an investor chooses the preservation of capital over the potential for a higher than average return
As cost of capital increases or decreases, how is project acceptance affected?
capital increases- more likely to accept project because of higher NPV
Capital decreases- less likely to accept project, lower NPV
When projects are mutually exclusive, what does this mean?
when you have to pick only one project
Explain what “correlation” means
measures the degree to which two securities mover in relation to one another
