CHAPTER 12 Risk, Cost of Capital, and Capital Budgeting Multiple Choice Questions: I. DEFINITIONS WACC e 1. The weighted average of the firm’s costs of equity, preferred stock, and after tax debt is the: a. reward to risk ratio for the firm. b. expected capital gains yield for the stock. c. expected capital gains yield for the firm. d. portfolio beta for the firm. e. weighted average cost of capital (WACC). Difficulty level: Easy CAPM b 2. If the CAPM is used to estimate
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market place, where all the risky assets refer to (say) all the tradeable stocks available to all. In addition we have a risk-free asset (for borrowing and/or lending in unlimited quantities) with interest rate rf . We assume that all information is available to all such as covariances, variances, mean rates of return of stocks and so on. We also assume that everyone is a risk-averse rational investor who uses the same financial engineering mean-variance portfolio theory from Markowitz. A little
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(both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio of all the company's existing securities". It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. Cost of debt The cost of debt is computed by taking the rate on a risk free bond whose duration matches the term structure of the corporate debt, then adding
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For MAR and the NYSE index, determine the monthly average return on the share price, the related variance and standard deviation. What does the standard deviation measure? Compare the standard deviation and monthly average returns of the NYSE index and MAR. What do your calculations suggest about the relationship between risk and return? (12 marks) Definition of 'Standard Deviation' A measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher
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Explain the importance of risk adjustment in the capital budgeting allocation process by answering the following questions. a. Explain why risk adjustments are important and how they can affect firm value. b. Explain how the single hurdle rate currently used by Northern Forest Products can change the risk structure of the company. For example, think about what would happen if the Plastic Products Division received a disproportionately high level of funding because their returns exceed the company hurdle
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discount rate. The issue arises when managers are investing in risky projects because they tend to value the risky projects the same way they do riskless projects. Here we have highlighted the two appropriate methods used to value risky projects, the Risk-Adjusted Discount Rate method and the Certainty Equivalent Method. TRACKING PORTFOLIOS AND REAL ASSET VALUATION Portfolio tracking is monitoring a collection of stocks, for the purpose of learning how the prices move and/or profiting from those
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the 1990 Nobel Prize, Harry Markowitz, will be the primary influence on the portfolio structure and subsequent decisions. The underlying concepts of Modern Portfolio Theory include: Investors are risk averse. The only acceptable risk is that which is adequately compensated for by potential portfolio returns. The portfolio as a whole is more important than an individual security. The appropriate allocation of capital among asset classes (stocks, bonds, cash, etc.) will have more influence on long-term
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Q: 3: I have argued that investors take on greater risks because they have more money to invest and they already have low risk investments like government bonds, prime commercial property and blue chip shares. Does the FCIC report provide any evidence that this view is correct? History emerged with continuous record breaking issues. In the arena of finance and economics, this turns into a collapsing shape. Shaky sentiment though was felt when this kind of financial turbulence starts. But, it becomes
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Risk Management Set I 6-1. (Expected rate of return and risk) Carter Inc. is evaluating a security. One-year Treasury bills are currently paying 9.1 percent. Calculate the investment’s expected return and its standard deviation. Should Carter invest in this security? PROBABILITY RETURN .15 6% .30 9% .40 10% .15 15% Expected Rate of Return: (.15x.06) + (.30x09) + (.40x.1) + (.15x.15) .009 + .027 + .04 + .0225= .0985 or 9.85% Standard Deviation: √((.15)(.06x.0985)^2
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portfolio from automobile sector consisting of equity from Maruti Suzuki India Ltd, Hero MotoCorp Ltd, Bajaj Auto India Ltd, Mahindra and Mahindra Ltd and Tata Motors Ltd. Keywords: Monte Carlo Simulation, Future Value, Portfolio I. Introduction Return on an investment is a possibility and not a certainty, the first criteria
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