Question

Which of the following is FALSE?
Select one:
a. A portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components.
b. A firm has high sales when the economy is expanding and low sales during a recession. This firm's overall risk will be higher if it invests in another product which is counter cyclical.
c. A portfolio that combines two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the least risky asset.
d. Uncorrelated assets have correlation coefficient close to zero

Which of the following basic variables must be considered in determining the initial investment associated with a capital expenditure?
Select one:
a. profits on the sale of an existing asset
b. changes in net working capital
c. incremental annual savings produced by the new asset
d. cash flows generated by the new investment

Which of the following is FALSE?
Select one:
a. Using the Capital Asset Pricing Model (CAPM), the cost of common stock equity is the return required by investors as compensation for a firm's nondiversifiable risk.
b. Weights that use accounting values to measure the proportion of each type of capital in a firm's financial structure are called market value weights.
c. Use of the capital asset pricing model (CAPM) in measuring the cost of common stock equity differs from the constant-growth valuation model in that it directly considers the firm's risk as reflected by beta.
d. Weights that use accounting values to measure the proportion of each type of capital in a firm's financial structure are called book value weights.

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Abdul-Rahim Taysir

Answer 1

PART A of the Question :

This statement (b) A firm has high sales when the economy is expanding and low sales during a recession. This firm's overall risk will be higher if it invests in another product which is counter cyclical is FALSE.

Justification : Counter-cyclical stocks refer to the shares of those companies that outperform or even rise during economic downturns or recessions, making them good diversifiers. Therefore investing in such stocks would not increase the overall risk for the firm.

PART B of the question :

The answer is sub part (c) incremental annual savings produced by the new asset.

Incremental annual saving has no effect in determination of initial investment associated with capital expenditure.

PART C of the question :

The statement (b) Weights that use accounting values to measure the proportion of each type of capital in a firm's financial structure are called market value weights is FALSE.

Justification : Weights that use accounting values to measure the proportion of each type of capital in a firm's financial structure are called book value weights and not market value weights.

Market value weights are weights that use market values to measure the proportion of each type of capital in the firm's financial structure, used in calculating the weighted average cost of capital.