Question

Which of the following is an example of firm-specific risk?

Group of answer choices

A.) An auto company recalls its vehicles due to the fuel emission problem.

B.) The financial crisis in U.S. causes security prices around the globe to fall.

C.) Federal Reserve increases the short-term interest rate by 0.25%.

The corporate tax rate is lowered from 35% to 20% by the government’s new tax bill. D.)

2.)

he weighted average cost of capital for a firm:

Group of answer choices

is unaffected when there is any change in the corporate tax rate.

remains constant when the firm’s capital structure changes.

is equivalent to the after-tax cost of the firm’s outstanding debt.

is a weighted average between the cost of equity and the (after-tax) cost of debt.

3.)

John saves $100 in the bank with a positive interest rate (r>0). He can earn an interest of $20 after 4 years of saving. If the compound interest is applied to his saving, how much interest would John earn after 8 years?

Group of answer choices

It would be more than $40.

It would be less than $40.

It would be equal to $40.

This cannot be determined unless the interest rate is told.

Answer 1

1. Option (A) is correct

Firm specific risk is when an auto company recalls its vehicles due to the fuel emmission problem.

2. Option (D) is correct

The weighted averge cost of capital of a firm is a weighted average between the cost of equity and the after tax cost of debt.

3. Option (A) is correct

First we will calculate the rate of interest as per below:

Here we will use the following formula:

FV = PV * (1 + r%)ⁿ

where, FV = Future value = $100 + $20 = $120, PV = Present value = $100, r = rate of interest , n= time period = 4

now, putting theses values in the above equation, we get,

$120 = $100 * (1 + r)⁴

$120 / $100 = (1 + r)⁴

1.2 = (1 + r)⁴

(1.2)^1/4= 1 + r

1.04663  = 1 + r

r = 1.04663 - 1

r = 0.04663 or 4.66%

Now, in the same way we will calculate the value after 8 years as per below:

FV = PV * (1 + r%)ⁿ

where, FV = Future value, PV = Present value = $100, r = rate of interest = 4.66% , n= time period = 8

now, putting theses values in the above equation, we get,

FV = $100 * (1 + 4.66%)⁸

FV = $100 * (1 + 0.0466)⁸

FV = $100 * (1.0466)⁸

FV = $100 * 1.4396132

FV = $143.96

Interest = $143.96 - $100 = $43.96