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bammers
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Joined: 18 Feb 2010
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Posted: 18 Jan 2011 at 11:54 \| IP Logged

#113 on pg 240 of 2011 Wiley text

Mgmt of Kelly, Inc uses CAPM to calculate the estimated cost of common equity. Which of the following would reduce the firm's estimated cost of common equity?

a. a reduction in the risk-free rate

b. an increase in the firm's beta

c. An increase in expected inflation

d. an increase in the risk-free interest rate

The correct answer according to Wiley is 'a', but when I plugged some numbers into the CAPM formula and decreased the risk-free rate, the cost of equity increased and when I increased the risk-free interest rate, the cost of equity decreased...so why isn't answer 'd' the correct answer?

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Yaeger/wiley
Colorado candidate - NASBA

Steelers11
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Joined: 16 Nov 2010
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Posted: 18 Jan 2011 at 12:31 \| IP Logged

Hey Bammers,

The answer depends on what the BETA is. If the beta is
above market risk premium i.e Greater than 1, then you're
right D should be the answer.

But if the Beta is less than 1, then A would be the correct
answer. Plug it in and youll see for yourself.

__________________
FAR: 87
AUD: 87
BEC: Jan 11, 2011
REG: TBD

bammers
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Joined: 18 Feb 2010
Location: United States
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Posts: 68

Posted: 18 Jan 2011 at 13:19 \| IP Logged

Thanks, Steelers. So should we always assume that beta is less than 1 when dealing w/CAPM, unless otherwise stated?

__________________
FAR 8/29 - 78
AUD 10/2 - 69, retake 2/26 84
REG 11/8 - 79
BEC 1/24 - 75
DONE!!! God is GREAT!

Yaeger/wiley
Colorado candidate - NASBA

Steelers11
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Joined: 16 Nov 2010
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Posts: 27

Posted: 18 Jan 2011 at 13:35 \| IP Logged

Hey Bammers,

No information concerning the Beta was provided in the question?

Thats Bizarre, clearly answers A and D would be acceptable. I wouldnt think
one should make that assumption.

__________________
FAR: 87
AUD: 87
BEC: Jan 11, 2011
REG: TBD

bammers
Contributor

Joined: 18 Feb 2010
Location: United States
Online Status: Offline
Posts: 68

Posted: 18 Jan 2011 at 13:56 \| IP Logged

Correct, no other info was provided. I'm gonna just cross it out and hope that the actual exam doesn't ask such a question without providing additional information.

__________________
FAR 8/29 - 78
AUD 10/2 - 69, retake 2/26 84
REG 11/8 - 79
BEC 1/24 - 75
DONE!!! God is GREAT!

Yaeger/wiley
Colorado candidate - NASBA

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