Which one of the following statements related to the Security Market Line approach to equity valuation is correct? Assume the firm includes debt in its capital structure. Group of answer choices This model considers a firm's rate of growth. The model will never produce the same cost of equity as the dividend growth model. The model is dependent upon a reliable estimate of the market risk premium. This approach generally produces a cost of equity that equals the firm's overall cost of capital. The model applies only to non-dividend-paying firms.

Which one of the following statements related to the Security Market Line approach to equity valuation is correct? Assume the firm includes debt in its capital structure. Group of answer choices This model considers a firm's rate of growth. The model will never produce the same cost of equity as the dividend growth model. The model is dependent upon a reliable estimate of the market risk premium. This approach generally produces a cost of equity that equals the firm's overall cost of capital. The model applies only to non-dividend-paying firms.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter5: Risk Analysis

Section: Chapter Questions

Problem 2QE

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Which of the below statements does the MM Proposition I predict? A. In a perfect market, the value of a firm is independent of its capital structure B.In a perfect market, the discount rate depends on the capital structure C.In a perfect market, the value of a firm decreases in leverage D.In a perfect market, the NPY of investments depends on the existing debt/equity mix
Which of the following statements are CORRECT? Check all that apply: The aftertax cost of debt decreases when the market price of a bond increases. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. Cost of capital is also known as the minimum expected or required return an investment must offer to be attractive.
If a firm cannot invest retained earnings to earn a rate of returngreater than or equal to the required rate of return on retained earnings, it should return those funds to its stockholders. The cost of equity using the CAPM approach The current risk-free rate of return (rRFrRF) is 4.67% while the market risk premium is 5.75%. The Burris Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Burris’s cost of equity is . The cost of equity using the bond yield plus risk premium approach The Taylor Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Taylor’s bonds yield 11.52%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Taylor’s cost of internal equity is: 18.84% 15.07% 14.32% 18.08% The…
Which one of the followings is incorrect regarding to cost of equity: On average, it is higher than cost of debt. It moves in the same direction with tax rates. It is affected by return on market portfolio. For a dividend paying company, it is sensitive to growth expectations for future dividends. It is highly dependent on risk level of the firm and growth rate. For calculating cost of equity, we can rely on dividend growth model or SML approach. Both models might suffer from the assumption that past is a good predictor of future. True False Percy's Wholesale Supply has earnings before interest and taxes of €106,000. Both the book and the market value of debt is €170,000. The unlevered cost of equity is 15.5 per cent while the pre-tax cost of debt is 8.6 per cent. The tax rate is 28 per cent. What is the firm's weighted average cost of capital? Show your steps.
Is the debt level that maximizes a firm's expected EPS the same as the one that maximizes its stock price? Explain. Explain how a firm might shift its capital structure so as to change its weighted average cost of capital (WACC). What would be the impact on the value of the firm?
What is the relationship between the expected return of a stock and its fair expected return? When is a stock underpriced, overpriced, or fairly priced? Explain what happens to the firm’s cost of equity, cost of debt, and cost of capital when the firm increases the amount of debt in its capital structure. Assume all Modigliani and Miller assumptions hold and that there are no taxes. How can we use the internal rate of return to evaluate whether we should pursue a specific project? Should we pursue a project when the cost of capital is higher than the internal rate of return?
If the debt component in the capital structure is predominant – a. Earnings per share (EPS) will be very low. b. Dividend expectations of equity shareholders are also and P/E Ratio may decrease. c. The fixed interest cost of the firm will be minimum thereby decreasing its risk. d. The fixed interest cost of the firm increases thereby increasing its risk.
According to Modigliani & Miller M Proposition II (MM Il), as a firm's debt-equity ratio decreases, what happens to the required rate of return on equity? Briefly explain including the key aspect of MM II.
Which statement is correct, all else held constant? A. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. B. The aftertax cost of debt increases when the market price of a bond increases. C. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. D. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
a. What is the relationship between the expected return of a stock and its fair expected return? When is a stock underpriced, overpriced, or fairly priced? b. Explain what happens to the firm’s cost of equity, cost of debt, and cost of capital when the firm increases the amount of debt in its capital structure. Assume all Modigliani and Miller assumptions hold and that there are no taxes. c. How can we use the internal rate of return to evaluate whether we should pursue a specific project? Should we pursue a project when the cost of capital is higher than the internal rate of return?
Which statement is false regarding the Capital Asset Pricing Model? A. The beta coefficient of a stock is constant. B. The risk free rate is usually based on the treasury bill yield. C. Market risk premium is the difference between market return and the risk free rate. D. The cost of retained earnings is equal to the cost of new shares issued.
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