Firms raise capital at the total corporate level by retaining earnings and by ob
ID: 2763754 • Letter: F
Question
Firms raise capital at the total corporate level by retaining earnings and by obtaining funds in the capital markets. They then provide funds to their different divisions for investment in capital projects. The divisions may vary in risk, and the projects within the divisions may also vary in risk. Therefore, it is conceptually correct to use different risk-adjusted costs of capital for different capital budgeting projects.
True or False?
When estimating the cost of equity by use of the CAPM, three potential problems are (1) whether to use long-term or short-term rates for rRF, (2) whether or not the historical beta is the beta that investors use when evaluating the stock, and (3) how to measure the market risk premium, RPM. These problems leave us unsure of the true value of rs.
True or False?
Explanation / Answer
1. It is true that the divisions in the company vary in risk , even the risks in the projects within a division also varies in risk. So it is conceptually correct to use different risk adjusted cost of capital for different Capital projects.
So The statement is TRUE.
2. The statement is TRUE. Three potential problems for CAPM determination are whether to use short term or long term risk free rates , whether to use historical beta and the measurement of market risk premium.
The Statement is TRUE.
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