1. Review the valuation principle and how it helps a financial manager make decisions. In the early 1980s, inflation was in the double digits and the yield curve sloped sharply downward. What did this yield curve suggest about the financial manager’s / investor’s expectations about future rates? Explain how a downward sloping yield curve affects the prices of existing long-term bonds and stocks trading in the secondary market, assuming this change in the yield curve is the only change that occurs. Would you characterize the change in the yield curve as a systematic or unsystematic risk?
2. How is the NPV rule related to the goal of maximizing shareholder wealth, and under what conditions would you expect the NPV and IRR rules to return the same accept / reject decision? Identify one problem with using IRR as part of this decision-making process. What value might the financial decision maker gain by adding the profitability index to the decision-making process?
3. Why might the constant dividend growth model (CDGM) and capital asset pricing model (CAPM) produce different estimates of the cost of equity capital used in the weighted average cost of capital (WACC)? Describe the difference between permanent and temporary working capital. What are some factors an organization considers when it chooses the mix of long- and short-term capital to finance the organization’s activities?
4. What are some advantages of valuating a stock based on discounted cash flows? With the availability of cash flow valuations, why might investors display trading biases and what might be some potential consequences? Why might corporations use call features and restrictive covenants on bond issues?