Which of the following is true? a. Everything else remaining constant, the present value of a...

Which of the following is true?

a. Everything else remaining constant, the present value of a future lump sum payment will increase if the time period declines. b. Everything else equal, you will accrue more interest if you choose to invest using simple interest versus compound interest. c. Everything else held constant, if the number of payments related to an annuity due increase, so will the present value of the annuity. d. All else equal, the future value of an annuity due will be greater than the future value of an ordinary annuity. “a”, “b”, “c” and “d” are correct only “a”, “b” and “c” are correct only “a” and “b” are correct only “b” and “c” are correct only “c” and “d” are correct

S. Bouchard and Company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D ₀ = $0.85; P ₀ = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $37.00. Based on the DCF approach, by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Do not round your intermediate calculations.

	a.	–1.79%
	b.	–1.39%
	c.	–1.81%
	d.	–1.73%
	e.	–1.66%

Expert Solution

1. Let's analyse each statement.

A. If time period declines, lump sum payment is multiplied with higher discount factor resulting in high present value. Therefore this statement is true.

B. Compound interest is always more or equal to simple interest due to compounding being done at regular intervals. therfore this statement is false.

C. True, If the payment .

D. True, as annuity due will always be more than ordinary annuity considering the initial extra cash flow in annuity due.

Therefore A, C, D are correct.

2.

D 0	0.85
D1 (D0 *1.06)	0.90
Price of Equity	22.00	37.00
(Cost of Equity - G) = D1/ Price of Equity	4.10%	2.44%
Add G (6%) to above	10.10%	8.44%
Difference in Cost of Equity		-1.66%

Therefore correct option is E.

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