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

question 76

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.
• Problems

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Definitions:

Inflation

The measure of growth in the overall price level for products and services, devaluing the currency's purchasing power.

Premium Bond

A bond sold at a price higher than its face value, typically occurring when it has a higher interest rate than the current market rate.

Face Value

The original value of a financial instrument as indicated on the certificate or instrument itself, equivalent to its par value.

Market

A venue or medium where buyers and sellers come together to exchange goods, services, or financial instruments.