Question 1

Slippery Slope Roof Contracting has an equity beta of 1.2, capital structure with 2/3 debt, and a zero tax rate. What is their asset beta?

Accepted Answer

The answer of Slippery Slope Roof Contracting has an equity...

Question 2

A firm with high operating leverage is characterized by _________ while one with high financial leverage is characterized by _____________.

Accepted Answer

A firm with high operating leverage has a high fixed cost of production, meaning that a significant portion of their costs are fixed and do not vary with changes in production levels. A firm with high financial leverage has a high fixed financial cost, meaning they have taken on a significant amount of debt and have to make fixed payments on that debt regardless of their level of operations.

Question 3

A firm with high operating leverage has:

Accepted Answer

High operating leverage is characterized by high amounts of fixed costs in the production process, which means that as sales increase, profits increase at a faster rate due to the spread of fixed costs over a larger number of units.

Question 4

Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ____________ than the beta of the common stock of an unlevered firm.

Accepted Answer

The beta of the common stock of a levered firm is greater than that of an unlevered firm because leveraging increases the risk to equity holders, which is reflected in a higher beta.

Question 5

For a multi-product firm, if a project's beta is different from that of the overall firm, then:

Accepted Answer

The project should be discounted at a rate commensurate with its own beta because the beta reflects the project's own systematic risk, which may differ from the overall firm's risk profile. This ensures that the discount rate accurately reflects the project's risk.

Question 6

If a stock's monthly return is consistently positive when the market's monthly return is negative, and vice-versa, then the beta of the company's stock will likely be:

Accepted Answer

Beta measures the sensitivity of a stock's returns to the returns of the market. A negative beta indicates that the stock's returns move in the opposite direction of the market's returns, which is described in the scenario.

Question 7

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 for Simmons' common is:

Accepted Answer

The expected return can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * Market Risk Premium = 5% + 1.6 * 4% = 11.4%.

Question 8

Companies that have highly cyclical sales will have a:

Accepted Answer

Beta measures a stock's volatility relative to the overall market. A company with highly cyclical sales that are dependent on the market cycle will have a high beta, indicating that its stock price is more volatile and closely follows market fluctuations.

Question 9

RKKL is considering buying a company that has no leverage but an asset beta of.7. The market risk premium is 6% and the risk-free rate is 2%. If they plan to use 75% debt, what will the required rate of return be?

Accepted Answer

The required rate of return is the risk-free rate plus the market risk premium times the asset beta times the debt-to-equity ratio. In this case, the required rate of return is 2% + 6% * 0.7 * 0.75 = 18.8%.

Question 10

The beta of a portfolio of the firm's debt and equity:

Accepted Answer

The beta of a portfolio is calculated as the weighted average of the betas of its components, with the weights being their respective market values. This accounts for the different sizes and risks of the components in the overall portfolio risk.

Question 11

Two firms have the same operating structure and the same operating systematic risk, ß = .8. Firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. If the tax rate faced by both firms is 0.4 which has the riskier equity?

Accepted Answer

Firm 2 has a higher ratio of debt to equity (4 units of debt for every 7 units of equity, which is more leveraged than Firm 1's 20% debt), making its equity riskier due to the increased financial leverage.

Question 12

The $\beta$ of all equity firm versus the $\beta$of the same firm with leverage is different:

Accepted Answer

The $\beta$ of the assets are not exposed to financial leverage, whereas the $\beta$ of the equity is affected by the firm's leverage.

Question 13

An industry is likely to have a low beta if the:

Accepted Answer

Beta measures a stock's volatility in relation to the overall market. A low beta indicates that the stock's price movements are less volatile than the market. Therefore, an industry with a stable and less volatile stream of revenues compared to the market will likely have a low beta.

Question 14

A firm with cyclical earnings is characterized by:

Accepted Answer

Cyclical earnings mean that the firm's revenue patterns fluctuate with the business cycle, increasing during economic expansions and decreasing during recessions.

Question 15

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:

Accepted Answer

The beta can be calculated using the Capital Asset Pricing Model (CAPM) formula: Expected Return = Risk-Free Rate + Beta * Market Risk Premium. Plugging in the given values: 12% = 5% + Beta * 6%. Solving for Beta gives: Beta = (12% - 5%) / 6% = 7% / 6% = 1.17.

Question 16

The beta of a firm is more likely to be high under what two conditions?

Accepted Answer

High cyclical business activity means the firm's earnings are highly sensitive to economic cycles, and high operating leverage means a larger portion of costs are fixed, making earnings more volatile with sales changes. Both conditions increase the firm's beta, indicating higher risk and sensitivity to market movements.

Question 17

If a firm has low fixed costs relative to all other firms in the same industry, a large change in volume (either up or down) would have:

Accepted Answer

Firms with low fixed costs relative to variable costs are less sensitive to changes in volume, leading to smaller changes in Earnings Before Interest and Taxes (EBIT) when volume changes significantly. This is because their costs more closely align with their revenue changes.

Question 18

Two firms have the same operating structure and the same operating systematic risk, ß = .8. firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. The tax rate faced by both firms is.4. The debt beta is assumed to zero. What is the difference in systematic risk between the riskier firm and the less risky firm?

Accepted Answer

Firm 1 has a debt-to-equity ratio of 0.25 (20% debt), while Firm 2 has a debt-to-equity ratio of 4/7. Using the formula for levered beta: βL = βU * [1 + (1 - tax rate) * (D/E)], we calculate the difference in levered betas. The difference is 0.15.

Question 19

Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to have:

Accepted Answer

Firms with high operating leverage and cyclical revenues are more sensitive to economic cycles, leading to higher volatility in their stock prices compared to the market. This results in high betas, indicating a strong correlation with market movements.

Question 20

Beta is useful in the calculation of:

Accepted Answer

Beta is used in the Capital Asset Pricing Model (CAPM) to calculate a company's expected return, which is part of determining the discount rate. The discount rate reflects the risk associated with the company's future cash flows. Beta measures the volatility of a stock or portfolio in relation to the overall market, thus helping in assessing the risk and determining the appropriate discount rate.

Quiz 13: Risk, Return, and Capital Budgeting

Slippery Slope Roof Contracting has an equity beta of 1.2, capital structure with 2/3 debt, and a zero tax rate. What is their asset beta?

A firm with high operating leverage is characterized by _ while one with high financial leverage is characterized by _____.

A firm with high operating leverage has:

Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ____________ than the beta of the common stock of an unlevered firm.

For a multi-product firm, if a project's beta is different from that of the overall firm, then:

If a stock's monthly return is consistently positive when the market's monthly return is negative, and vice-versa, then the beta of the company's stock will likely be:

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 for Simmons' common is:

Companies that have highly cyclical sales will have a:

RKKL is considering buying a company that has no leverage but an asset beta of.7. The market risk premium is 6% and the risk-free rate is 2%. If they plan to use 75% debt, what will the required rate of return be?

The beta of a portfolio of the firm's debt and equity:

Two firms have the same operating structure and the same operating systematic risk, ß = .8. Firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. If the tax rate faced by both firms is 0.4 which has the riskier equity?

The $\beta$ of all equity firm versus the $\beta$ of the same firm with leverage is different:

An industry is likely to have a low beta if the:

A firm with cyclical earnings is characterized by:

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:

The beta of a firm is more likely to be high under what two conditions?

If a firm has low fixed costs relative to all other firms in the same industry, a large change in volume (either up or down) would have:

Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to have:

Beta is useful in the calculation of:

Quiz 13: Risk, Return, and Capital Budgeting

Slippery Slope Roof Contracting has an equity beta of 1.2, capital structure with 2/3 debt, and a zero tax rate. What is their asset beta?

A firm with high operating leverage is characterized by _________ while one with high financial leverage is characterized by _____________.

A firm with high operating leverage has:

Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ____________ than the beta of the common stock of an unlevered firm.

For a multi-product firm, if a project's beta is different from that of the overall firm, then:

If a stock's monthly return is consistently positive when the market's monthly return is negative, and vice-versa, then the beta of the company's stock will likely be:

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 for Simmons' common is:

Companies that have highly cyclical sales will have a:

RKKL is considering buying a company that has no leverage but an asset beta of.7. The market risk premium is 6% and the risk-free rate is 2%. If they plan to use 75% debt, what will the required rate of return be?

The beta of a portfolio of the firm's debt and equity:

Two firms have the same operating structure and the same operating systematic risk, ß = .8. Firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. If the tax rate faced by both firms is 0.4 which has the riskier equity?

The β\betaβ of all equity firm versus the β\betaβ of the same firm with leverage is different:

An industry is likely to have a low beta if the:

A firm with cyclical earnings is characterized by:

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:

The beta of a firm is more likely to be high under what two conditions?

If a firm has low fixed costs relative to all other firms in the same industry, a large change in volume (either up or down) would have:

Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to have:

Beta is useful in the calculation of:

A firm with high operating leverage is characterized by _ while one with high financial leverage is characterized by _____.

The $\beta$ of all equity firm versus the $\beta$ of the same firm with leverage is different: