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    Determining Systemic Risk, WACC, and Note Discount

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    1. LipTea Incorporated purchases raw materials and has processing plants around the world.
    The standard deviation of the firmâ s equity returns is 1.2 times as great as the marketâ s standard deviation of returns. If the correlation of LipTeaâ s returns with the marketâ s is 0.80, what is the systematic risk of the firm?

    A. 1.20
    B. 0.96
    C. 1.50
    D. There is not enough information to answer this question.

    2. Ready Supply Co. has a cost of debt of 8%. The risk-free rate of interest is 3% and the expected return on the market portfolio is 10%. If the firm has a beta of 0.90 and an effective tax rate of 30% with a capital structure that is 40% debt and 60% equity, what is the firm's weighted average cost of capital?

    A. 9.30%
    B. 7.82%
    C. 8.00%
    D. 5.60%

    3. Seine River Insurance Company plans to issue $5,000,000 of Euro-commercial paper with a 90-day maturity discounted to yield 4.00% per annum. What will be the immediate proceeds to Seine River Insurance?

    A. euro 4,807,692
    B. $4,950,495
    C. $4,807,692
    D. $5,000,000

    4. TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/euro at the time the loan was made to $1.45/euro at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?

    A. $37,931
    B. $79,750
    C. $55,000
    D. $77,000

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    Solution Preview

    1. The beta coefficient is a measure of a firm's returns relative to the overall market. It is undiversified or systematic risk because if the market drops, the firm's value will, as well. Because the question states that the standard deviation of the firm's equity returns is 1.2 times as great as the market's standard deviation of returns, this is the beta or ...

    Solution Summary

    This solution addresses three issues: the difference between systematic risk and market risk, the computation of the weighted-average cost of capital, and the computation of a discount on commercial paper.