WEB APPENDIX 12D—TECHNIQUES FOR MEASURING BETA RISK
1. Which of the following methods involves calculating an average beta for comparable firms and using that beta to
determine a project’s beta?
a.
Risk premium method
b.
Pure play method
c.
Accounting beta method
d.
CAPM method
e.
Discounted cash flow model
b
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MODERATE
12D Techniques for Measuring Beta Risk
FOFM.BRIG.16.12.12D – Techniques for Measuring Beta Risk
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Pure play method
Multiple Choice: Conceptual
2. Northern Conglomerate has two divisions, Division A and Division B. Northern looks at competing pure-play firms to
estimate the betas of each of the two divisions. After this analysis, Northern concludes that Division A has a beta of 0.8
and Division B has a beta of 1.5. The two divisions are the same size. The risk-free rate is 5% and the market risk
premium is 6%. Assume that Northern is 100% equity financed. What is the overall composite WACC for Northern
Conglomerate?
a.
10.74%
b.
11.31%
c.
11.90%
d.
12.50%
e.
13.12%
c
WEB APPENDIX 12D—TECHNIQUES FOR MEASURING BETA RISK
WACC = 11.90%
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12D Techniques for Measuring Beta Risk
FOFM.BRIG.16.12.12D – Techniques for Measuring Beta Risk
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Corporate WACC with divisions
Bloom’s: Application
Multiple Choice: Problem
3. Interstate Transport has a target capital structure of 50% debt and 50% common equity. The firm is considering a new
independent project that has a return of 13% and is not related to transportation. However, a pure-play proxy firm has
been identified that has a beta of 1.38. Both firms have a marginal tax rate of 40%, and Interstate’s before-tax cost of debt
is 12%. The risk-free rate is 10% and the market risk premium is 5%. The firm should:
a.
Reject the project; its return is less than the firm’s required rate of return on the project of 16.9%.
b.
Accept the project; its return is greater than the firm’s required rate of return on the project of 12.05%.
c.
Reject the project; its return is only 13%.
d.
Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt.
e.
Be indifferent between accepting or rejecting; the firm’s required rate of return on the project equals its
expected return.
b
Exp. project return
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12D Techniques for Measuring Beta Risk
