Problems 1
The CAPM computer expected rate of return using the following model (described in the chapter)
E[REj] = E[RF] + ?j x {E[RM] - E[RF]}
explain the role of each of the three components of the model.
Problems 2
Non diversifiable and diversifiable risk factors. Identify the type of firm specific factors that increase a firm's non-diversifiable risk (systematic risk). Identity the firm specific factors that increase a firm's diversifiable risk (idiosyncratic risk or nonsystematic risk). Why do models of risk adjusted expected return premia for diversifiable risk?
Problems 3
Debt and the weighted average cost of capital: why do investors typically accept a lower risk adjusted rate of return on debt capital that equity capital? Suppose a stable, financially healthy, profitable tax paying firm that has been financed with all equity and not debt decides to add a reasonable amount of debt to its capital structure. What effect will that change in capital structure likely have on the firm's weighted average cost of capital?
Problems 4
The dividends valuation approach. Explain the theory behind the dividends valuation approach. Why are dividends values relevant to common equity shareholders?
Problems 5
The free cash flows valuation approach. Explain the theory behind that free cash flows valuation approach. Why are free cash flows value relevant to common equity shareholders when they are not cahs flow to those shareholder, but rather are cash flows in the firm?
Problems 6
The free cash flows valuation when free cash flow are negative. Suppose you are valuing healthy growing profitable firm and you project that the firm will generate negative free cash flows for equity shareholders in each of the next five year. Can you use the free cash flows valuation approach when cash flows valuation approach when cash flows are negative? If so describe how the free cash flows approach can produce valuations of firms when they are expected to generate negative free cash flows over the next five years.