Strayer FIN534 Week 5 Homework Assignment Chapter 9

FIN 534 Week 5 Homework
Assignment Chapter 9
1. When working with the
CAPM, which of the following factors can be determined with the most precision?
a. The beta coefficient, bi, of a relatively safe stock.
b. The most appropriate risk-free
rate, rRF.
c. The expected rate of return on
the market, rM.
d. The beta coefficient of “the
market,” which is the same as the beta of an average stock.
e. The market risk premium (RPM).
2. Bloom and Co. has no debt or
preferred stock¾it uses only equity capital, and has two equally-sized divisions.
Division X’s cost of capital is 10.0%, Division Y’s cost is 14.0%, and the
corporate (composite) WACC is 12.0%. All of Division X’s projects are equally
risky, as are all of Division Y’s projects. However, the projects of Division X
are less risky than those of Division Y. Which of the following projects should
the firm accept?
a. A Division Y project with a
12% return.
b. A Division X project with an
11% return.
c. A Division X project with a 9%
return.
d. A Division Y project with an
11% return.
e. A Division Y project with a
13% return.
3. Taylor Inc. estimates that its
average-risk projects have a WACC of 10%, its below-average risk projects have
a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of
the following projects (A, B, and C) should the company accept?
a. Project C, which is of
above-average risk and has a return of 11%.
b. Project A, which is of average
risk and has a return of 9%.
c. None of the projects should be
accepted.
d. All of the projects should be
accepted.
e. Project B, which is of
below-average risk and has a return of 8.5%.
4. Weatherall Enterprises has no
debt or preferred stock¾it is an all-equity firm¾and has a beta of 2.0. The chief financial officer is evaluating a
project with an expected return of 14%, before any risk adjustment. The
risk-free rate is 5%, and the market risk premium is 4%. The project being
evaluated is riskier than an average project, in terms of both its beta risk
and its total risk. Which of the following statements is CORRECT?
a. The project should definitely
be rejected because its expected return (before risk adjustment) is less than
its required return.
b. Riskier-than-average projects
should have their expected returns increased to reflect their higher risk.
Clearly, this would make the project acceptable regardless of the amount of the
adjustment.
c. The accept/reject decision
depends on the firm’s risk-adjustment policy. If Weatherall’s policy is to
increase the required return on a riskier-than-average project to 3% over rS, then it should reject the
project.
d. Capital budgeting projects
should be evaluated solely on the basis of their total risk. Thus, insufficient
information has been provided to make the accept/reject decision.
e. The project should definitely
be accepted because its expected return (before any risk adjustments) is
greater than its required return.
5. The Anderson Company has equal
amounts of low-risk, average-risk, and high-risk projects. The firm’s overall
WACC is 12%. The CFO believes that this is the correct WACC for the company’s
average-risk projects, but that a lower rate should be used for lower-risk
projects and a higher rate for higher-risk projects. The CEO disagrees, on the
grounds that even though projects have different risks, the WACC used to
evaluate each project should be the same because the company obtains capital
for all projects from the same sources. If the CEO’s position is accepted, what
is likely to happen over time?
a. The company will take on too
many low-risk projects and reject too many high-risk projects.
b. Things will generally even out
over time, and, therefore, the firm’s risk should remain constant over time.
c. The company’s overall WACC
should decrease over time because its stock price should be increasing.
d. The CEO’s recommendation would
maximize the firm’s intrinsic value.
e. The company will take on too
many high-risk projects and reject too many low-risk projects.