Question

1. Assuming all else is constant, which of the following statements is CORRECT? a. Other things...

1. Assuming all else is constant, which of the following statements is CORRECT?

a. Other things held constant, a 20-year zero coupon bond has more reinvestment risk than a 20-year coupon bond.
b. Other things held constant, price sensitivity as measured by the percentage change in price due to a given change in the required rate of return decreases as a bond's maturity increases.
c. Other things held constant, for any given maturity, a 1.0 percentage point decrease in the market interest rate would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase in the interest rate.
d. For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate.
e. From a corporate borrower's point of view, interest paid on bonds is not tax-deductible.

2. Keys Printing plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 45.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?

a. –0.42%
b. –0.44%
c. –0.30%
d. –0.36%
e. –0.35%

Homework Answers

Answer #1

1. Option d - For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate.

2. Option e: -0.35%

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