1."Compared to the valuations of debt and preferred stock, the valuation of common stock suffers most...

1."Compared to the valuations of debt and preferred stock, the valuation of common stock suffers most from information asymmetry problem due to mostly the uncertainty in the stock's beta." True or false? Select one: a. False b. True

2.

"The IRR method assumes that future cash inflows will be reinvested and earn a rate of return equal to the project's WACC." True or false?

Select one:

a. True

b. False

Expert Solution

1.. ANSWER: b. TRUE

Beta is defined as the risk associated with one security or a portfolio of securities , in relation to the rest of the market. Also called beta coefficient, it is a way of determining how much a stock may move in comparison to the market. It is a measure of volatility.

It is known that beta depends on past performance to determine the risk level.So, it cannot be relied heavily while forecasting the future risk associated with a particular stock ,bond or portfolio.In variation to the situation prevalent in both the past and the present , often risk-levels in the future differ from that were in the past. For instance, a new company's beta will be very low ,as the determinants like past prices are not available for longer pasts ,to form a range.

That said abount beta, respective beta does affect valuations of all the three types of securities, namely, common stock ,preferred stocks & debt .

But,it is the common stock that is affected more because of the inherent unpredictable nature of the movement of its beta-----

as debt & preferred stocks have assured returns,in that order--given preference over common stock, in the event of liquidation .

2. a.TRUE

IRR assumes that all future cash inflows(revenues /income-earned from the project)are reinvested in the on-going project itself , at the project's weighted average cost of capital,ie. Cost of funds borrowed to finance the project--(negative cash flows like initial investment, working capital introduced,etc.

jeff jeffy answered 2 years ago

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1."Compared to the valuations of debt and preferred stock, the valuation of common stock suffers most...

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