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Chapter 13 - Risk, Cost of Capital, and Capital Budgeting

45. Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if the firm's equity has a beta of 1.2, the risk-free rate of return is 2%, the expected return on the market is 9%, and the return to the company's debt is 7%? A. 10.4% B. 10.8% C. 12.8% D. 14.4%

E. None of the above.

Rs = Rf + ?(Rm - Rf) = .02 + 1.2(.09 - .02) = .104 = 10.4%

Difficulty level: Medium Topic: CAPM Type: PROBLEMS

46. The cost of equity for Ryan Corporation is 8.4%. If the expected return on the market is 10% and the risk-free rate is 5%, then the equity beta is ___. A. 0.48 B. 0.68 C. 1.25 D. 1.68

E. Impossible to calculate with information given. Rs = Rf + ? (Rm - Rf); .084 = .05 + ? (.10 - .05); ? = .68

Difficulty level: Medium Topic: EQUITY BETA Type: PROBLEMS

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Chapter 13 - Risk, Cost of Capital, and Capital Budgeting

47. Suppose that the Simmons Corporation's common stock has a beta of 1.6. If the risk-free rate is 5% and the market risk premium is 4%, the expected return on Simmons' common stock is:

A. 4.0%. B. 5.0%. C. 5.6%. D. 10.6%. E. 11.4%.

Rs = Rf + ?(Rm - Rf) = .05 + 1.6(.04) = .114 = 11.4%

Difficulty level: Easy Topic: CAPM Type: PROBLEMS

48. Suppose the Barges Corporation's common stock has an expected return of 12%. Assume that the risk-free rate is 5%, and the market risk premium is 6%. If no unsystematic influence affected Barges' return, the beta for Barges is ______. A. 1.00 B. 1.17 C. 1.20 D. 2.50

E. It is impossible to calculate with the information given. Rs = Rf + ?(Rm - Rf); .12 = .05 + ?(.06); ? = .07/.06 = 1.17

Difficulty level: Medium

Topic: CALCULATING BETA Type: PROBLEMS

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Chapter 13 - Risk, Cost of Capital, and Capital Budgeting

49. Slippery Slope Roof Contracting has an equity beta of 1.2, capital structure with 2/3 debt, and a zero tax rate. What is its asset beta? A. 0.40 B. 0.72 C. 1.20 D. 1.80

E. None of the above

?A = (E/(D + E.) ?E = (1/3)(1.2) = .40

Difficulty level: Medium Topic: ASSET BETA Type: PROBLEMS

50. The Template Corporation has an equity beta of 1.2 and a debt beta of .8. The firm's market value debt to equity ratio is .6. Template has a zero tax rate. What is the asset beta? A. 0.70 B. 0.72 C. 0.96 D. 1.04 E. 1.05

.8(.6/1.6) + 1.2(1/1.6) = 1.05

Difficulty level: Medium Topic: ASSET BETA Type: PROBLEMS

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Chapter 13 - Risk, Cost of Capital, and Capital Budgeting

51. The NuPress Valet Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. The appropriate discount rate, assuming average risk, is: A. 8.65% B. 9% C. 9.47% D. 10.5% E. 13%

WACC = .09(1 - .34)(.5) + .13(.5) = .0297 + .065 = .0947 = 9.47%

Difficulty level: Easy Topic: WACC Type: PROBLEMS

Essay Questions

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