It is relatively simple to calculate the cost of debt – the interest or coupon
the company is obligated to pay its bondholders is the cost it incurs.
Equity Investments MCQ - Equity Investments Section 2
Selling unproductive assets and using the proceeds from the sale to buy
back shares reduces the total assets. Holding sales constant the decrease
in assets would improve the asset turnover. Buying back shares increases
the firm’s financial leverage. Both the increase in asset turnover and
financial leverage will lead to a higher return on equity.
28
A mutual fund manager is looking to invest in a company’s stock with the
following characteristics:
following characteristics:
| Risk-free rate | 2.50% |
| Market risk premium | 4.30% |
| Stock’s beta | 1.9 |
| Manager’s expected rate of return | 9.55% |
| Company’s weighted average cost of capital | 9.25% |
Based on this information, which of the following would be most appropriate investment decision for the fund manager?
Stock’s required return according to CAPM = risk free rate + beta *
market risk premium = 0.025 + 1.9 * 0.043 = 10.67%. Since the stock’s
required return (10.67%) is greater than the expected rate of return
(9.55%), the correct decision is to not invest.
Indexing and passive investing strategies would not engage in over- or
underweighting of industries, industry rotation, or timing investments in
industries. Therefore, industry analysis is not useful to such investors or
portfolio managers. Performance attribution, which addresses sources of a
portfolio’s returns, utilizes industry analysis and classification.
