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 the cost of equity capital, the expected excess market return is equal to the: a. return on the stock minus the risk-free rate. b. difference between the return on the market and the risk-free rate. c. beta
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d. an average rate across prior projects is acceptable because estimates contain errors. e. one must have the actual data to determine any differences in the calculations.

Difficulty level: Easy

SECURITY MARKET LINE a 10. If the project beta and IRR coordinates plot above the SML the project should be: a. accepted. b. rejected. c. It is impossible to tell. d. It will depend on the NPV. e. None of the above.

Difficulty level: Medium

BETA d 11. The beta of a security provides an: a. estimate of the market risk premium. b. estimate of the slope of the Capital Market Line. c. estimate of the slope of the Security Market Line. d. estimate of the systematic risk of the security. e. None of the above.

Difficulty level: Easy

BETA ESTIMATION a 12. Regression analysis can be used to estimate: a. beta. b. the risk-free rate. c. standard deviation. d. variance. e. expected return.

Difficulty level: Easy

BETA d 13. Beta measures depend highly on the: a. direction of the market variance. b. overall cycle of the market. c. variance of the market and asset, but not their co-movement. d. covariance of the security with the market and how they are correlated. e. All of the

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