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
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%
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.