Firms 1 7 operate in the industries shown. All seven firms are considering projects in the
Question:
Firms 1 – 7 operate in the industries shown. All seven firms are considering projects in the industries shown, to be financed using the same mix of debt and equity (B/V and S/V, respectively) as finances existing projects. The firms’ stock betas are shown.
| Corporation: | Firm 1 | Firm 2 | Firm 3 | Firm 4 | Firm 5 | Firm 6 | Firm 7 |
| Current Business: | Industries 1 & 2 | Industries 3 & 4 | Industry 1 | Industry 2 | Industry 3 | Industry 4 | Industry 4 |
| B/V S/V | 0.0000 1.0000 | 0.2000 0.8000 | 0.0000 1.0000 | 0.0000 1.0000 | 0.1000 0.9000 | 0.3000 0.7000 | 0.0000 1.0000 |
| βS | 0.9000 | 1.2420 | 0.6000 | 1.1000 | 0.8533 | 1.8857 | 1.5000 |
| Project: | Industry 1 | Industry 3 | Industry 1 | Industry 1 | Industry 3 | Industry 2 | Industry 2 |
| Notes: | T = 0.40 and RB = 0.03 for all firms. The risk-free return is 1% per year. The market risk premium is 7% per year. | ||||||
1. Which of the following statements is most accurate?
a. Firm 1’s stock beta lies between the asset betas of Firms 3 and 4.
b. Firm 1’s cost of equity (RS) is the correct discount rate for its project.
c. Firm 1’s cost of equity for the project is 0.064 or 6.4%.
2. Which of the following statements is most accurate?
a. Firm 2’s weighted average cost of capital (WACC) is the correct discount rate for this project.
b. Firm 2 may rightly use Firm 5 as a proxy firm to find a discount rate for its project.
c. Firm 2 may rightly use Firm 5’s WACC as the discount rate for this project.
3. Which of the following statements is inaccurate?
a. Firms 3 and 4 may rightly use the same discount rate for their projects.
b. The discount rate for Firm 5’s project is 0.065 or 6.5%.
c. The rate of return Firm 5 stockholders require on existing projects is 0.061 or 6.1%.
4. Which of the following statements is most accurate?
a. Existing projects at Firms 6 and 7 have the same asset beta.
b. Stockholders at Firm 6 require a lower rate of return on the firm’s existing projects than stockholders at Firm 7 require on their firm’s existing projects.
c. Firms 6 and 7 are both pure-play firms undertaking expansion / replacement projects.
Expert Answer:
The detailed answer for the above question is provided below Answer 1 a Firm 1s stock beta lies between the asset ... View the full answer
