Other Things Held Constant, the Value of an Option Depends

question 19

Multiple Choice

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

• A) The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal.
• B) The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used.
• C) An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity.
• D) The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure.

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Definitions:

Placebos

Inert substances or treatments used as controls in experiments, testing the effectiveness of medical interventions without any active ingredients.

Inactive Substances

Substances that have no intended therapeutic effect; often used as placebos in clinical trials to assess the efficacy of active treatments.

Fake Treatments

Interventions or procedures that are designed to mimic real treatments but do not contain any active ingredients or therapeutic value, often used in the context of clinical trials as placebos.

Experiment

A controlled test of a hypothesis in which the researcher manipulates one variable to discover its effect on another.