As financial manager of Material Supplies Inc., you have recently participated in an executive committee decision to enter into the plastics business.Much to your surprise, the price of the firm's common stock subsequently declined from $40 per share to $30 per share.While there have been several changes in financial markets during this period, you are anxious to determine how the market perceives the relevant risk of your firm.Assume that the market is in equilibrium.From the following data you find that the beta value associated with your firm has changed from an old beta of ____ to a new beta of ____.

Question

Quizplus · Accepted Answer

The decrease in the stock price indicates that the market perceives more risk associated with the firm after the decision to enter into the plastics business. The relationship between beta and market risk implies that the beta value of the firm should have increased due to perceived additional risk. Since there is a decrease in stock price, we can presume that this firm has more risk than before, and therefore its beta has increased. For that reason, the old beta must be less than the new beta. As the given choices indicate an increase in the beta value, we can eliminate option B as it mentions a decrease in beta. Among the remaining choices, C represents the largest proportional increase in beta, which is consistent with the stock price decline. Therefore, the correct answer is C, which implies an increase in beta from 2.00 to 3.17.

As Financial Manager of Material Supplies Inc