Final answer:
The value of a firm is larger when a lower risk premium is used to compute its value, as it reflects lower expected risk and makes future cash flows more valuable today.
Step-by-step explanation:
The value of a firm is larger the lower is the risk premium used to compute the firm's value. When calculating this value, we consider the present value of expected future cash flows, such as dividends and potential capital gains. A lower risk premium indicates lower expected risk, which makes the firm's future cash flows more valuable in today's terms. As a result, investors are willing to pay more for the company, increasing its value. When it comes to bonds, the present value calculation is also key. If interest rates decrease after a bond is issued, the bond's value increases because it offers a relatively higher rate than what is currently available. Conversely, if interest rates rise, the bond becomes less attractive as it is locked at a lower rate, and its value decreases. These dynamics reflect the fundamental principle that the value of an investment is tied to the present value of its expected benefits.