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Unformatted text preview: Chapter 10 Discussion Questions 10-1. How is valuation of any financial asset related to future cash flows? The valuation of a financial asset is equal to the present value of future cash flows. 10-2. Why might investors demand a lower rate of return for an investment in Exxon Mobil as compared to United Airlines? Because Exxon Mobil has less risk than United Airlines, Exxon Mobil has relatively high returns and a strong market position; United Airlines has had financial difficulties and emerged from bankruptcy in 2006. 10-3. What are the three factors that influence the required rate of return by investors? The three factors that influence the demanded rate of return are: a. The real rate of return b. The inflation premium c. The risk premium 10-4. If inflationary expectations increase, what is likely to happen to yield to maturity on bonds in the marketplace? What is also likely to happen to the price of bonds? If inflationary expectations increase, the yield to maturity (required rate of return) will increase. This will mean a lower bond price. 10-5. Why is the remaining time to maturity an important factor in evaluating the impact of a change in yield to maturity on bond prices? The longer the time period remaining to maturity, the greater the impact of a difference between the rate the bond is paying and the current yield to maturity (required rate of return). For example, a two percent ($20) differential is not very significant for one year, but very significant for 20 years. In the latter case, it will have a much greater effect on the bond price. S10-1 10-6. What are the three adjustments that have to be made in going from annual to semiannual bond analysis? The three adjustments in going from annual to semiannual bond analysis are: 1. Divide the annual interest rate by two. 2. Multiply the number of years by two. 3. Divide the annual yield to maturity by two. 10-7. Why is a change in required yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds? The longer the life of an investment, the greater the impact of a change in the required rate of return. Since preferred stock has a perpetual life, the impact is likely to be at a maximum. 10-8. What type of dividend pattern for common stock is similar to the dividend payment for preferred stock? The no-growth pattern for common stock is similar to the dividend on preferred stock. 10-9. What two conditions must be met to go from Formula 10-8 to Formula 10-9 in using the dividend valuation model? ( 29 9 10 g- K D P e 1- = To go from Formula (10-8) to Formula (10-9): The firm must have a constant growth rate (g). The discount rate (k e ) must exceed the growth rate (g)....
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- Spring '10