Question

1. For corporation, bond is a A obligation, but management of a corporation has B duty to its common shareholders

what is A and B?

2. High Financial Leverage or high Operating leverage makes a company’s earnings more ____________.

3. The discount rate used to calculate the PV of cash flows expected to be received in the future must consider 2 factors.

What are two factors?

4. If interest is paid more than once a year APR or EAR will be > APR or EAR.

Answer 1

1.A. Debt

B.Fiduciary

Bond is a debt obligation because the management is contractually oblidged to pay back the debt with interest and principal.

For Shareholders there is no such contractual obligation. But management the the trustee of shareholders money. As a trustee it has fiduciary obligation to the shareholders

2.High Financial Leverage or high Operating leverage makes a company’s earnings more RISKY.

Operating Leverage will be higher if there is higher fixed costs. Financial leverage will be higher with higher debts. In both the cases, the companys earning may increase with higher leverage but the risk also increases.

3.The two factos to be considered to determine the discount rates are:

1. Cost of Capital

2. Risk of the project.

4.Assume APR=12%

If Interest is paid monthly ,

Monthly effective interest =12/12=1%=0.01

Effective Annual Rate (EAR)=((1+0.01)^12)-1=0.1268

Effective Annual Rate (EAR)=12.68% which is higher than APR

ANSWER:If interest is paid more than once a year EAR will be > APR