Appendix 12C Cost of Capital: Using the CAPM
Answers and Solutions
12C-1
Web Appendix 12C
Using the CAPM to Estimate the Risk-Adjusted
Cost of Capital
Answers to Questions
12C-1 If the firm used only the corporate WACC to evaluate projects, it would be more likely to accept the
higher-risk projects with the higher returns (although they might not cover their appropriate cost)
than the lower-risk projects with lower returns (even though these projects did in fact cover their
costs). Consequently, the firm’s risk would increase as would its WACC because the firm would
consist of a larger percentage of high-risk projects. If the firm’s required return increased without a
corresponding increase in its expected returns, then the firm’s value would decline.
12C-2
Answers and Solutions
Appendix 12C Cost of Capital: Using the CAPM
Solutions to Problems
12C-1 a. b = 0.75(1.5) + 0.25(0.5)
= 1.125 + 0.125
= 1.25.
b. rG = 9% + (13% – 9%)1.25
= 9% + 5%
= 14%.
12C-2 New investment’s b = 0.5;
r
ˆ
New project = 7%.
rFirm = 10.75%; bFirm = 1.25; double assets.
12C-3 rFirm = 16%; rRF = 10%; RPM = 5%.
bNew project = 1.5bFirm;
r
ˆ
New project = 18%; accept new project?
rFirm = 10% + (5%)b
bNew project = 1.5 1.2 = 1.8.