For the cost of equity (stock) is it better to use the current US Treasury bill rate or a longer-term government bond rate as the risk-free rate of return? Does the rate you use as the risk-free rate have an impact on what market premium might be appropriate? Historically, large-company stocks have earned an average return of 12.1% per annum, while US Treasury bills and long-term government bonds have earned average returns of 3.5% and 5.9% respectively.

For the cost of equity (stock) is it better to use the current US Treasury bill rate or a longer-term government bond rate as the risk-free rate of return? Does the rate you use as the risk-free rate have an impact on what market premium might be appropriate? Historically, large-company stocks have earned an average return of 12.1% per annum, while US Treasury bills and long-term government bonds have earned average returns of 3.5% and 5.9% respectively.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter12: The Cost Of Capital

Section: Chapter Questions

Problem 10QTD

See similar textbooks

Similar questions

For the cost of equity (stock) is it better to use the current US Treasury bill rate or a longer-termgovernment bond rate as the risk-free rate of return?
Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company's common stock? (Hint: in your explanation consider alternative investment to common stocks; a relatively riskless investment)
Which statement is NOT correct? The distribution of returns does not affect the expected average rate of return. To find the dividend yield, we can subtract the capital gain yield from the total stock return. Average geometric return is a better indicator than the average arithmetic return for the growth. Wider the distribution of return, riskier is the investment. The current risk premium for U.S. Treasury bills is 0%.
If the current rate on U.S. Treasuries are 5.3% and the current rate on stocks are 8%, then what is the risk premium to invest in stocks? 2.7% O 5.3% 8% 13.3%
What happens to ROE for Firm U and Firm L if EBIT falls to $1,600? What happens if EBIT falls to $1,200? What is the after-tax cost of debt? What does this imply about the impact of leverage on risk and return?
Refer the table below on the average excess return of the U.S. equity market and the standard deviation of that excess return. Suppose that the U.S. market is your risky portfolio. Period 1927-2021 1927-1950 1951-1974 1975-1998 1999-2021 Average Annual Returns U.S. equity 12.17 10.26 10.21 17.97 10.16 1-Month T-Bills 3.30 0.93 3.59 6.98 1.66 U.S. Excess return 8.87 9.33 6.62 10.99 8.50 Equity Market Standard Deviation 20.25 26.57 20.32 14.40 18.85 Sharpe Ratio 0.44 0.35 0.33 0.76 0.45 Required: a. If your risk-aversion coefficient is A = 4.9 and you believe that the entire 1927-2021 period is representative of future expected performance, what fraction of your portfolio should be allocated to T-bills and what fraction to equity? Assume your utility function is u = E(r) 0.5 × Ao². b. What if you believe that the 1975-1998 period is representative?
Consider the following scenario analysis A. Is it reasonable to assume that treasury bonds will provide higher returns in recessions than in booms? B. Calculate the expected rate of return and standard deviation for each investment. C. What investment would you prefer?
The following question illustrates the APT. Imagine that there are only two pervasive macroeconomic factors. Investments X, Y, and Z have the following sensitivities to these two factors: Investments b1 b2 X 1.75 0.25 Y 1.00 2.00 Z 2.00 1.00 Assume that the expected risk premium is 4% on factor 1 and 8% on factor 2. Treasury bills offer zero risk premium. a. According to the APT, what is the risk premium on each of the three stocks? b. Suppose you buy $200 of X and $50 of Y and sell $150 of Z. What is the sensitivity of your portfolio to each of the two factors? What is the expected risk premium? c. Suppose you buy $80 of X and $60 of Y and sell $40 of Z. What is the sensitivity of your portfolio to…
Which of the following is false? 1. When given the annual withdrawals desired during the retirement period, PVA tells us the amount we should have accumulated by the time we retire. II. For fixed-rate fully amortized mortage loans, less of the fixed payment goes towards interest as we approach the end of the loan term. III. The right-hand side variables in the PV formula represent the three key factors determining stock prices. O A. O B. O C. OD. None of the above All of the above II only I only
Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest ratesin Europe. What effect would this have on the price of an average company’s common stock?
Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond pM, and the optimal consumption in the two states cM, cM. Compare the mutual fund and bond market allocations: are c4 and c bigger or smaller than cf and c, respectively?
What is the difference in the interest rates on commercial paper for financial firms versus nonfinancial firms? Explain possible reasons for the difference. What is the most recent interest rate reported for, 1-year, 2-year, 5-year, 10-year, and 30-year maturity Treasuries? Provide the graph of the rates over the maturity (the yield curve) and interpret the shape of the yield curve. 2. The most famous financial market in the world is the New York Stock Exchange (NYSE). Visit the NYSE website and then answer the following questions: ● What is the mission of the NYSE? ● What would be the fee for a firm with five million common shares outstanding?