Week2 FIN 620 Long-term Financial Management umuc

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Factors affecting Beta

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What factors determine the beta of a stock?  Define and describe each.

 

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Both Dow Chemical Company, a large natural gas user, and Superior Oil, a
major natural gas producer, are thinking of investing in natural gas 
wells near Houston.  Both are all-equity financed companies.  Dow and 
Superior are looking at identical projects.  They have analyzed their 
respective investments, which would involve a negative cash flow now and
positive expected cash flows in the future.  These cash flows would be 
the same for both firms.  No debt would be used to finance the projects.
 Both companies estimate that their projects would have a net present 
value of $1 million at an 18 percent discount rate and a -$1.1 million 
NPV at a 22 percent discount rate.  Dow has a beta of 1.25 whereas 
Superior has a discount rate of .75.  The expected risk premium on the 
market is 8 percent and risk-free bonds are yielding 12 percent.  Should
either company proceed?  Should both? Explain.

SML and the Cost of Equity Equation

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What are the advantage of using the SML approach to finding the cost of 
capital?  What are the disadvantages?  What are the specific pieces of 
information needed to use this method?  Are all of these variables 
observable or do they need to be estimated?  What are some of the ways 
you could get these estimates?

    • 11 years ago
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