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:

Utilities

Services such as water, electricity, gas, and sewer provided to consumers and businesses.

Primary Material

The main raw materials used in the production of goods or services, often a critical component in manufacturing processes.

Indirect Labor

Labor costs not directly tied to the production of goods or services, such as salary of supervisory staff.

Depreciation

The systematic allocation of the cost of a tangible asset over its useful life to reflect its decrease in value over time.