Firm M's Earnings and Stock Price Tend to Move Up

question 84

Multiple Choice

Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500,while Firm W's earnings and stock price move counter cyclically with M and other S&P companies.Both M and W estimate their costs of equity using the CAPM,they have identical market values,their standard deviations of returns are identical,and they both finance only with common equity.Which of the following statements is CORRECT?

• A) M should have the lower WACC because it is like most other companies,and investors like that fact.
• B) M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical.
• C) If M and W merge,then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs.
• D) Without additional information,it is impossible to predict what the merged firm's WACC would be if M and W merged.
• E) Since M and W move counter cyclically to one another,if they merged,the merged firm's WACC would be less than the simple average of the two firms' WACCs.

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Definitions:

Functional Chimneys Problem

Issues arising from the lack of communication and coordination among different departments within an organization, leading to siloed operations.

Ecological Fallacy

The assumption that a generalized cultural value applies equally well to all members of the culture.

Natural Monopoly

A market situation where a single firm can supply a product or service to an entire market at a lower cost than what two or more firms can.

Long Run

In economics, a period during which all inputs, including capital, are variable and firms can enter or exit the industry, allowing full production adjustment.