Which of the Following Statements Is Correct? Assume That the Firm

question 21

Multiple Choice

Which of the following statements is correct? Assume that the firm is a publicly owned corporation and is seeking to maximize shareholder wealth.

• A) If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively correlated with the returns on most other firms' assets.
• B) If a firm's managers want to maximize the value of the stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project's expected future cash flows.
• C) If a firm evaluates all projects using the same cost of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time.
• D) Project A has a standard deviation of expected returns of 20%, while Project B's standard deviation is only 10%. A's returns are negatively correlated with both the firm's other assets and the returns on most stocks in the economy, while B's returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a
• Lower cost of capital.

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Definitions:

Posterior Probabilities

Probabilities that are updated or revised after taking into account new evidence or information.

Bayes' Theorem

A mathematical formula that describes how to update the probabilities of hypotheses when given evidence.

Multiplication Law

A probability rule that determines the likelihood of two independent events occurring together by multiplying their individual probabilities.

Chebyshev's Theorem

A statistical theorem stating that for any set of data, the proportion of results that fall within k standard deviations from the mean is at least 1-1/k^2 for k>1.