Exam 9: Risk and the Cost of Capital

A project has an expected risky cash flow of $200 in year 1. The risk-free rate is 6 percent, the expected market rate of return is 16 percent, and the project's beta is 1.50. Calculate the certainty equivalent cash flow for year 1, CEQ₁.

Discuss why one might use an industry beta to estimate a company's cost of capital.

Briefly discuss the certainty equivalent approach to estimating the NPV of a project.

Financial slang referring to the reduction of cash flows from a project's forecasted value to its certainty equivalent is a(n)

Which of the following projects most likely has the lowest cost of capital?

Generally, an industry beta, calculated from a portfolio of companies in the same industry, is more accurate than a beta estimate for a single company.

Using a company's cost of capital to evaluate a project is I.always correct; II.always incorrect; III.correct for projects that have average risk compared to the firm's other assets

One calculates the after-tax weighted average cost of capital (WACC)using which of the following formulas?

Briefly explain how a firm's cost of equity is estimated using the capital asset pricing model (CAPM).

Generally, one should use the short-term Treasury bill rate for the risk-free rate.

The cost of capital is always less than or equal to the cost of equity.

Generally, for CAPM calculations, the value to use for the risk-free interest rate is the

The hurdle rate for capital budgeting decisions is

A project has an expected risky cash flow of $500 in year 3. The risk-free rate is 4 percent, the expected market rate of return is 14 percent, and the project's beta is 1.20. Calculate the certainty equivalent cash flow for year 3, CEQ₃.

Firms with cyclical revenues tend to have lower asset betas.

Which of the following types of projects generally have the highest total risk?