Consider the following statements about a firm: I. The debt beta of a firm is usually quite low. If we assume that the debt beta is zero, the equity beta of a firm must exceed the asset beta of the firm. II. If the WACC is used to evaluate a project that is more risky than the other operations of the firm, then there is a chance that a project will be rejected incorrectly III. Shareholders, as residual claimants to the profits of a firm, tend to remain owners of highly leveraged firms when they feel that the benefits of the tax deductibility of interest payments to their creditors outweighs the risk of bankruptcy. It is apparent that: a) only statement I is true b) only statement II is true c) only statement III is true d) only statements I and II are true e) only statements I and III are true
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Consider the following statements about a firm:
I. The debt beta of a firm is usually quite low. If we assume that the debt beta is zero, the equity beta of a firm must exceed the asset beta of the firm.
II. If the WACC is used to evaluate a project that is more risky than the other operations of the firm, then there is a chance that a project will be rejected incorrectly
III. Shareholders, as residual claimants to the profits of a firm, tend to remain owners of highly leveraged firms when they feel that the benefits of the tax deductibility of interest payments to their creditors outweighs the risk of bankruptcy.
It is apparent that:
a) only statement I is true
b) only statement II is true
c) only statement III is true
d) only statements I and II are true
e) only statements I and III are true
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