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AnswerKeyAnswerKeyChapter13Risk,CostofCapital,andCapitalBudgetingMultipleChoiceQuestionsTheweightedaverageofthefirm'scostsofequity,preferredstock,andaftertaxdebtisthe:rewardtoriskratioforthefirm.expectedcapitalgainsyieldforthestock.expectedcapitalgainsyieldforthefirm.portfoliobetaforthefirm.weightedaveragecostofcapital(WACC).Difficultylevel:EasyTopic:WACCType:DEFINITIONSIftheCAPMisusedtoestimatethecostofequitycapital,theexpectedexcessmarketreturnisequaltothe:returnonthestockminustherisk-freerate.differencebetweenthereturnonthemarketandtherisk-freerate.betatimesthemarketriskpremium.betatimestherisk-freerate.marketrateofreturn.Difficultylevel:EasyTopic:CAPMType:DEFINITIONSDifficultylevel:EasyDifficultylevel:EasyTopic:WACCType:CONCEPTSDifficultylevel:EasyDifficultylevel:EasyTopic:WACCType:CONCEPTSDifficultylevel:MediumDifficultylevel:MediumTopic:WEIGHTEDAVERAGECOSTOFCAPITALType:DEFINITIONSThebestfitlineofapairwiseplotofthereturnsofthesecurityagainstthemarketindexreturnsiscalledthe:SecurityMarketLine.CapitalMarketLine.characteristicline.riskline.Noneoftheabove.Difficultylevel:MediumTopic:CHARACTERISTICLINEType:DEFINITIONSTheuseofdebtiscalled:operatingductionleverage.financialleverage.totalassetturnoverrisk.businessrisk.Difficultylevel:MediumTopic:USEOFDEBTType:DEFINITIONSTheweightedaveragecostofcapitalforafirmisthe:discountratewhichthefirmshouldapplytoalloftheprojectsitundertakes.overallratewhichthefirmmustearnonitsexistingassetstomaintainthevalueofitsstock.ratethefirmshouldexpecttopayonitsnextbondissue.maximumratewhichthefirmshouldrequireonanyprojectsitundertakes.rateofreturnthatthefirm'spreferredstockholdersshouldexpecttoearnoverthelongterm.TheWACCisusedtotheexpectedcashflowswhenthefirmhasA.discount;debtandequityinthecapitalstructureB.discount;shorttermfinancingonthebalancesheetC.increase;debtandequityinthecapitalstructureD.decrease;shorttermfinancingonthebalancesheetE.Noneoftheabove.Difficultylevel:MediumTopic:WACCType:CONCEPTSUsingtheCAPMocalculatethecostofcapitalforariskyprojectassumesthat:usingthefirm'sbetaisthesamemeasureofriskastheproject.thefirmisall-equityfinanced.thefinancialriskisequaltobusinessrisk.BothAandB.BothAandC.Difficultylevel:MediumTopic:CAPMType:CONCEPTSTheuseofWACCtoselectinvestmentsisacceptablewhenthe:correlationofallnewprojectsareequal.NPVispositivewhendiscountedbytheWACC.riskoftheprojectsareequaltotheriskofthefirm.firmiswelldiversifiedandtheunsystematicriskisnegligible.Noneoftheabove.Iftheriskofaninvestmentprojectisdifferentthanthefirm'sriskthen:A.youmustadjustthediscountratefortheprojectbasedonthefirm'srisk.B.youmustadjustthediscountratefortheprojectbasedontheprojectrisk.C.youmustexerciseriskaversionandusethemarketrate.anaveragerateacrosspriorprojectsisacceptablebecauseestimatescontainerrors.onemusthavetheactualdatatodetermineanydifferencesinthecalculations.Difficultylevel:EasyTopic:DISCOUNTRATEType:CONCEPTSIftheprojectbetaandIRRcoordinatesplotabovetheSMLtheprojectshouldbe:accepted.rejected.Itisimpossibletotell.ItwilldependontheNPV.Noneoftheabove.Difficultylevel:MediumTopic:SECURITYMARKETLINEType:CONCEPTSThebetaofasecurityprovidesan:estimateofthemarketriskpremium.estimateoftheslopeoftheCapitalMarketLine.estimateoftheslopeoftheSecurityMarketLine.estimateofthesystematicriskofthesecurity.Noneoftheabove.Difficultylevel:MediumDifficultylevel:MediumTopic:INDUSTRYORFIRMBETAType:CONCEPTSDifficultylevel:MediumDifficultylevel:MediumTopic:INDUSTRYORFIRMBETAType:CONCEPTSDifficultylevel:MediumDifficultylevel:MediumTopic:BETAType:CONCEPTSRegressionanalysiscanbeusedtoestimate:beta.therisk-freerate.standarddeviation.variance.expectedreturn.Difficultylevel:EasyTopic:BETAESTIMATIONType:CONCEPTSBetameasuresdependhighlyonthe:directionofthemarketvariance.overallcycleofthemarket.varianceofthemarketandasset,butnottheirco-movement.covarianceofthesecuritywiththemarketandhowtheyarecorrelated.Alloftheabove.Difficultylevel:MediumTopic:BETAType:CONCEPTSTheformulaforcalculatingbetaisgivenbythedividingtheofthestockwiththemarketportfoliobytheofthemarketportfolio.variance;covariancecovariance;variancestandarddeviation;varianceexpectedreturn;varianceexpectedreturn;covarianceTheslopeofthecharacteristiclineistheestimated:intercept.beta.unsystematicrisk.marketvariance.marketriskpremium.Difficultylevel:MediumTopic:BETAANDCHARACTERISTICLINEType:CONCEPTSCompaniesthathavehighlycyclicalsaleswillhavea:lowbetaifsalesarehighlydependentonthemarketcycle.highbetaifsalesarehighlydependentonthemarketcycle.highbetaifsalesareindependentofthemarketcycle.Alloftheabove.Noneoftheabove.Difficultylevel:MediumTopic:CYCLICALBUSINESSANDBETAType:CONCEPTSBetasmayvarysubstantiallyacrossanindustry.Thedecisiontousetheindustryorfirmbetatoestimatethecostofcapitaldependson:howsmalltheestimationerrorsareofallbetasacrossindustries.howsimilarthefirm'soperationsaretotheoperationsofallotherfirmsintheindustry.whetherthecompanyisaleaderorfollower.thesizeofthecompany'spublicfloat.Noneoftheabove.Difficultylevel:MediumDifficultylevel:MediumTopic:DETERMINANTSOFBETAType:CONCEPTSDifficultylevel:MediumDifficultylevel:MediumTopic:FIRM'SBETAType:CONCEPTSBetaisusefulinthecalculationofthe:company'spany'sdiscountpany'sstandarddeviation.unsystematicpany'smarketrate.Difficultylevel:MediumTopic:BETAType:CONCEPTSForamulti-productfirm,ifaproject'sbetaisdifferentfromthatoftheoverallfirm,thenthe:CAPMcannolongerbejectshouldbediscountedusingtheoverallfirm'sjectshouldbediscountedataratecommensuratewithitsownjectshouldbediscountedatthemarketjectshouldbediscountedattheT-billrate.Difficultylevel:MediumTopic:PROJECTANDFIRMBETAType:CONCEPTSTheproblemofusingtheoverallfirm'sbetaindiscountingprojectsofdifferentriskisthe:firmwouldaccepttoomanyhigh-riskprojects.firmwouldrejecttoomanylowriskprojects.firmwouldrejecttoomanyhigh-riskprojects.firmwouldaccepttoomanylowriskprojects.BothAandB.Theassetbetaofaleveredfirmisgenerally:equaltotheequitybeta.differentfromtheequitybeta.differentfromthedebtbeta.thesimpleaverageoftheequitybetaanddebtbeta.BothBandC.Difficultylevel:MediumTopic:ASSETBETAType:CONCEPTSComparingtwootherwiseequalfirms,thebetaofthecommonstockofaleveredfirmisthanthebetaofthecommonstockofanunleveredfirm.equaltosignificantlylessslightlylessgreaterNoneoftheabove.Difficultylevel:MediumTopic:LEVEREDVS.UNLEVEREDBETAType:CONCEPTSThebetaofafirmisdeterminedbywhichofthefollowingfirmcharacteristics?A.CyclesinrevenuesB.OperatingleverageC.FinancialleverageD.Alloftheabove.E.Noneoftheabove.Thebetaofafirmismorelikelytobehighunderwhattwoconditions?HighcyclicalbusinessactivityandlowoperatingleverageHighcyclicalbusinessactivityandhighoperatingleverageLowcyclicalbusinessactivityandlowfinancialleverageLowcyclicalbusinessactivityandlowoperatingleverageNoneoftheabove.Difficultylevel:MediumTopic:FACTORSAFFECTINGBETAType:CONCEPTSAfirmwithcyclicalearningsischaracterizedby:A.revenuepatternsthatvarywiththebusinesscycle.B.highlevelsofdebtinitscapitalstructure.highfixedcosts.highpriceperunit.lowcontributionmargins.Difficultylevel:MediumTopic:CYCLICALEARNINGSType:CONCEPTSAfirmwithhighoperatingleveragehas:A.lowfixedcostsinitsproductionprocess.B.highvariablecostsinitsproductionprocess.C.highfixedcostsinitsproductionprocess.D.highpriceperunit.E.lowpriceperunit.Difficultylevel:MediumTopic:OPERATINGLEVERAGEType:CONCEPTSIfafirmhaslowfixedcostsrelativetoallotherfirmsinthesameindustry,alargechangeinsalesvolume(eitherupordown)wouldhave:asmallerchangeinEBITforthefirmversustheotherfirms.noeffectinanywayonthefirmsasvolumedoesnoteffectfixedcosts.adecreasingeffectonthecyclicalnatureofthebusiness.alargerchangeinEBITforthefirmversustheotherfirms.Noneoftheabove.Difficultylevel:MediumTopic:OPERATINGLEVERAGEType:CONCEPTSAfirmwithhighoperatingleverageischaracterizedbywhileonewithhighfinancialleverageischaracterizedby.lowfixedcostofproduction;lowfixedfinancialcostshighvariablecostofproduction;highvariablefinancialcostshighfixedcostsofproduction;highfixedfinancialcostslowcostsofproduction;highfixedfinancialcostshighfixedcostsofproduction;lowvariablefinancialcostsDifficultylevel:MediumTopic:OPERATINGANDFINANCIALLEVERAGEType:CONCEPTSFirmswhoserevenuesarestronglycyclicalandwhoseoperatingleverageishigharelikelytohave:lowbetas.highbetas.zerobetas.negativebetas.Noneoftheabove.Anindustryislikelytohavealowbetaifthe:streamofrevenuesisstableandlessvolatilethanthemarket.economyisinarecession.marketforitsgoodsisunaffectedbythemarketcycle.BothAandB.BothAandC.Difficultylevel:MediumTopic:DETERMINANTSOFBETAType:CONCEPTSFortheleveredfirmtheequitybetaistheassetbeta.A.greaterthanB.lessthanC.equaltoD.sometimesgreaterthanandsometimeslessthanE.Noneoftheabove.Difficultylevel:MediumTopic:ASSETANDEQUITYBETASType:CONCEPTSAllelseequal,amoreliquidstockwillhavealowerbetamarketpremiumcostofcapitalBothAandB.BothAandC.Difficultylevel:ChallengeTopic:LIQUIDITYType:CONCEPTSDifficultylevel:MediumDifficultylevel:MediumTopic:BETAANDCORRELATIONType:CONCEPTSTwostockmarketbasedcostsofliquiditythataffectsthecostofcapitalarethe:bid-askspreadandthespecialistspread.marketimpactcostandthebrokeragecosts.investoropportunitycostandthebrokeragecosts.bid-askspreadandthemarketimpactcosts.Noneoftheabove.Difficultylevel:MediumTopic:LIQUIDITYType:CONCEPTSWhenaspecialistiscaughtinthemiddleofatradebetweeninformedanduniformedtraders,whicheffectivelyeliminatesthespreadorcausesaloss,issubjectto:marketimpactcosts.adverseselection.broker'squotationbias.increasingthenumberofuninformedtraders.Noneoftheabove.Difficultylevel:ChallengeTopic:ADVERSESELECTIONType:CONCEPTSAllelseequal,newshareholderswillthecapitalgainsofexistingshareholders.diluteholdconstantincreaseAlloftheaboveItisimpossibletotell.Difficultylevel:MediumTopic:CAPITALGAINSType:CONCEPTSThefollowingaremethodstoestimatethemarketriskpremium:usehistoricaldatatoestimatefutureriskpremium.usethedividenddiscountmodeltoestimateriskpremium.usethebondvaluationmodeltoestimategrowthinbondpriceswithdifferentcostsofcapital.AandB.AandC.Difficultylevel:MediumTopic:MARKETRISKPREMIUMType:CONCEPTSBetaistheslopeofthe:A.efficientfrontier.marketportfolio.securitymarketline.characteristicline.Noneoftheabove.Difficultylevel:MediumTopic:BETAType:CONCEPTSTwostocksthathavethesamebetahavethesamecorrelationbecausemay;becausecorrelationmeasuresthesensitivityoftheS&Ptothemarketportfolio.will;becausecorrelationmeasuresthetightnessoffitaroundtheregressionline.maynot;becausecorrelationmeasuresthetightnessoffitaroundtheregressionline.maynot;becausecorrelationmeasuresthesensitivitytochange.Noneoftheabove.Whenusingthecostofdebt,therelevantnumberisthe:pre-taxcostofdebtsincemostcorporationspaytaxesatthesametaxrate.B.pre-taxcostofdebtsinceitistheactualratethefirmispayingbondholders.post-taxcostofdebtsincedividendsaretaxdeductible.post-taxcostofdebtsinceinterestistaxdeductible.Noneoftheabove.Difficultylevel:MediumTopic:COSTOFDEBTType:CONCEPTSJack'sConstructionCo.has80,000bondsoutstandingthataresellingatparvalue.Bondswithsimilarcharacteristicsareyielding%.Thecompanyalsohas4millionsharesofcommonstockoutstanding.Thestockhasabetaofandsellsfor$40ashare.The.Treasurybillisyielding4%andthemarketriskpremiumis8%.Jack'staxrateis35%.WhatisJack'sweightedaveragecostofcapital?A.%B.%C.%D.%E.%R=.04+ .08)=.128Debt:80,000 $1,000=$80mCommon:4m$40=$160mTotal=$80m+$160m=$240mWACC=' x.128+1^S0nix.085x(l-.35)=.0853^3-.018417=J0375=1038%I$24Om )I$240m )Difficultylevel:MediumTopic:WEIGHTEDAVERAGECOSTOFCAPITALType:PROBLEMSPeter'sAudioShophasacostofdebtof7%,acostofequityof11%,andacostofpreferredstockof8%.Thefirmhas104,000sharesofcommonstockoutstandingatamarketpriceof$20ashare.Thereare40,000sharesofpreferredstockoutstandingatamarketpriceof$34ashare.Thebondissuehasatotalfacevalueof$500,000andsellsat102%offacevalue.Thetaxrateis34%.WhatistheweightedaveragecostofcapitalforPeter'sAudioShop?%%%%%Debt:$500,000 =$.51mPreferred:40,000 $34=$Common:104,000 $20=$Total=$.51m+$+$=$WACO=j|+[10J+'-^2-x.07xd-.34?|=057924+.027544I$395mJU395m ) 95m )+.005965=091433=914percentDifficultylevel:MediumTopic:WEIGHTEDAVERAGECOSTOFCAPITALType:PROBLEMSPhil'sCarvings,Inc.wantstohaveaweightedaveragecostofcapitalof9%.Thefirmhasanafter-taxcostofdebtof5%andacostofequityof11%.Whatdebt-equityratioisneededforthefirmtoachieveitstargetedweightedaveragecostofcapital?.0.67.09=[We.11]+[(1-W e) .05)=.11We+.05-.05We;.04=.06We;We=%；W=1-We=100%-%=%;Debt-equityratio=% %=.50Difficultylevel:MediumTopic:WEIGHTEDAVERAGECOSTOFCAPITALType:PROBLEMSJake'sSoundSystemshas210,000sharesofcommonstockoutstandingatamarketpriceof$36ashare.Lastmonth,Jake'spaidanannualdividendintheamountof$pershare.Thedividendgrowthrateis4%.Jake'salsohas6,000bondsoutstandingwithafacevalueof$1,000perbond.Thebondscarrya7%coupon,payinterestannually,andmatureinyears.Thebondsaresellingat99%offacevalue.Thecompany'staxrateis34%.WhatisJake'sweightedaveragecostofcapital?%%%%%Debt:6,000 $1,000 .99=$Common:210,000 $36=$Total=$+$=$R=[($ $36]+.04=.08602Enter4.89士990 70 10(10I/YPVPMTF\rSolveforWACC二7.250：$7.56mEnter4.89士990 70 10(10I/YPVPMTF\rSolveforWACC二7.250：$7.56mi$13.50m08602+r55.94mi$13.50m07250x(134)]=04817+02105-06922^^%Difficultylevel:MediumTopic:WEIGHTEDAVERAGECOSTOFCAPITALType:PROBLEMSTheConsolidatedTransferCo.isanall-equityfinancedfirm.Thebetais.75,themarketriskpremiumis8%andtherisk-freerateis4%.WhatistheexpectedreturnofConsolidated?7%8%9%立10%E.13%.04+(.08)=.10=10%Difficultylevel:EasyTopic:CAPMType:PROBLEMSAssumingtheCAPMorone-factormodelholds,whatisthecostofequityforafirmifthefirm'sequityhasabetaof,therisk-freerateofreturnis2%,theexpectedreturnonthemarketis9%,andthereturntothecompany'sdebtis7%?%%%%Noneoftheabove.Rs=Rf+(Rm-Rf)=.02+(.09-.02)=.104=%Difficultylevel:MediumTopic:CAPMType:PROBLEMSThecostofequityforRyanCorporationis%.Iftheexpectedreturnonthemarketis10%andtherisk-freerateis5%,thentheequitybetais.A.B.C.D.E.Impossibletocalculatewithinformatio