Exam 22: Using the CAPM to Estimate the Risk-Adjusted Cost of Capital

Louisiana Enterprises,an all-equity firm,is considering a new capital investment.Analysis has indicated that the proposed investment has a beta of 0.50 and will generate an expected return of 5.00%.The firm currently has a required return of 10.75% and a beta of 1.25.The investment,if undertaken,will double the firm's total assets.If r_RF is 7.00% and the market risk premium is 3.00%,should the firm undertake the investment?

If the firm is being operated so as to maximize shareholder wealth,and if our basic assumptions concerning the relationship between risk and return are true,then which of the following should be true?

Assume you are the director of capital budgeting for an all-equity firm.The firm's current cost of equity is 18.00%;the risk-free rate is 0.25%;and the market risk premium is 7.00%.You are considering a new project that has 50.00% more beta risk than your firm's assets currently have,that is,its beta is 50.00% larger than the firm's existing beta.The expected return on the new project is 18.00%.Should the project be accepted if beta risk is the appropriate risk measure? Choose the correct statement.

Sunshine Inc.has two equally-sized divisions.Division A has a beta of 0.8 and Division B has a beta of 1.2.The company is 100% equity financed.The risk-free rate is 6% and the market risk premium is 5%.Sunshine assigns different hurdle rates to each division based on each division's market risk.Which of the following statements is CORRECT?

Using the Security Market Line concept in capital budgeting,which of the following statements is CORRECT?