Fin 534 Homework Chapter 12

 

Again, looking at Standard Deviation for my friend. Because she is already highly risk averse (which means that she dislikes risk), I would choose Stock B because the SD is 8%. This is a safer bet for her low risk portfolio.

3. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE? a. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. b. The beta of an "average stock," or "the market," can change over time, sometimes drastically. c. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. d. All of the statements above are true. e. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

Explanation: In section 6-

7b, we learn that “a firm can influence its beta through changes on the

composition of its assets and also through its use of debt: Acquiring riskier assets will increase beta, as will a change in capital structure that calls for a higher debt ratio. A

company’s beta can also change as a result of external factors such as increased

competition in its industry, the expiration of basic patents, and the like. When such

changes lead to a higher or lower beta, the required rate of return will also change”

(Brigham & Ehrhardt, 2014).

4. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.) a. Stock B must be a more desirable addition to a portfolio than A. b. Stock A must be a more desirable addition to a portfolio than B. c. The expected return on Stock A should be greater than that on B. d. The expected return on Stock B should be greater than that on A. e. When held in isolation, Stock A has more risk than Stock B.

Explanation:

“A stock with a high standard deviation, will tend to have a high beta”, which can lead to

a higher rate of return (Brigham & Ehrhardt, 2014)

. Therefore, with Stock A’s beta at

1.7, then we should expect a greater rate of return for Stock A compared to Stock B.

5. Which of the following statements is CORRECT? a. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. b. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. c. The beta of a portfolio of stocks is always larger than the betas of any of the individual

 

In Section 11.1f Externalities of our book, we learn that cannibalization is a form of  Negative Within-

Firm Externalities. “The new business eats into the company’s existing  business”

(Brigham & Ehrhardt, 2014). The

 book explains Apple’s iPod model. By

 producing a newer model, the previous model is cannibalized. Therefore my answer D explains that cannibalization is not against the law and the only harm done is to itself.

3. Which of the following statements is CORRECT? a. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. b. Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes. c. Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions. d. Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV. e. Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV.

Explanation: I choose answer E, because of section 11-2e

 – 

 Evaluating Project Cash Flows (Accelerated Depreciation versus Straight-Line Depreciation). In this section, we learn more about accelerated depreciation and its effects of other resources. The book gives an example of accelerated depreciation versus straight-line depreciation and how it can affect NPV (Brigham & Ehrhardt, 2014).

4. Which of the following statements is CORRECT? a. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer. b. Corporations must use the same depreciation method for both stockholder reporting and tax purposes. c. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV. d. Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project. e. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.

Explanation: I choose answer C, because of section 11-2e

 – 

 Evaluating Project Cash Flows (Accelerated Depreciation versus Straight-Line Depreciation). The book gives an example of accelerated depreciation versus straight-line depreciation and how it can affect NPV (Brigham & Ehrhardt, 2014).

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