Chpter 12

Question 1

CAPM

Answer 1

method of calculating the return required on an investment based on its assessment of systematic risk

Question 2

When the business risk of an investment project differed from the risk of the investing company, the return required in the investment project is different from the return required on existing operations

Answer 2

True

Question 3

First step in CAPM

Answer 3

look for companies whose business operations are similar to the proposed investment project (proxy companies). Since their equity betas represent the business risk of the proxy companies business operations, they are referred to as proxy equity betas

Question 4

Steps in calculating project specific dicsount rate

Answer 4

Step 1: Find suitable proxy companies
Step 2: determine the equity betas of the proxy companies, their gearings and tax rates
Step 3: ungear the proxy equity betas to obtain asset betas
Step 4: calculate an average asset beta
Step5: rehear the asset beta
Step 6: use CAPM to calculate project specific cost of equity

Question 5

Risk fee premium

Answer 5

The extra return a shareholder expects to receive from an investment compared to a risk free asset like government bonds