fm10 2 - stockholders hold diversified portfolios of...

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Answers and Solutions: 10 - 2 10-3 Probable Effect on r d (1 - T) r s WACC a. The corporate tax rate is lowered. + 0 + b. The Federal Reserve tightens credit. + + + c. The firm uses more debt; that is, it increases its debt/assets ratio. + + 0 d. The firm doubles the amount of capital it raises during the year. 0 or + 0 or + 0 or + e. The firm expands into a risky new area. + + + f. Investors become more risk averse. + + + 10-4 Stand-alone risk views a project’s risk in isolation, hence without regard to portfolio effects; within-firm risk, also called corporate risk, views project risk within the context of the firm’s portfolio of assets; and market risk (beta) recognizes that the firm’s
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Unformatted text preview: stockholders hold diversified portfolios of stocks. In theory, market risk should be most relevant because of its direct effect on stock prices. 10-5 If a company’s composite WACC estimate were 10 percent, its managers might use 10 percent to evaluate average-risk projects, 12 percent for those with high-risk, and 8 percent for low-risk projects. Unfortunately, given the data, there is no completely satisfactory way to specify exactly how much higher or lower we should go in setting risk-adjusted costs of capital....
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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