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

question 2

Multiple Choice

Firm J's earnings and stock price tend to move up and down with other firms in the S&P 500,while Firm F's earnings and stock price move counter cyclically with J and other S&P companies.Both J and F 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) J and F should have identical WACCs because their risks as measured by the standard deviation of returns are identical.
• B) If J and F merge,then the merged firm MW should have a WACC that is a simple average of J's and F's WACCs.
• C) Without additional information,it is impossible to predict what the merged firm's WACC would be if J and F merged.
• D) Since J and F 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.
• E) J should have the lower WACC because it is like most other companies,and investors like that fact.

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Definitions:

Internal Rate of Return

A metric used in financial analysis to estimate the profitability of potential investments, calculating the interest rate at which the net present value of all cash flows is zero.

Compound Interest

Accumulated interest calculation that includes both the principal amount and the interest that has been gained on it from previous periods for loans or deposits.

Cash Inflow

Represents money or cash equivalents being transferred into a company, coming from various sources like sales, investments, or financing activities.

Present Value

A calculation that determines the current worth of a future sum of money or stream of cash flows given a specified rate of return.