Question

What is the beta of a portfolio made up of two risky assets and a risk-free asset? You invest 35% in asset A with a beta of 1.2 and 35% in asset B with a beta of 1.1?

Question 8 options:

1)

0.66

2)

0.81

3)

1.03

4)

1.14

5)

1.29

A firm has a cost of preferred stock 8%, and its yield to maturity is 10%. This firm has a tax rate of 35%. Given these information, which financing is cheaper for the firm: debt or preferred stock

Question 12 options:

1)

Debt

2)	Preferred stock

3)

Same

Which is a more relevant cost to a company?

Question 13 options:

1)	Before tax cost of debt

2)	After tax cost of debt

3)	Before tax cost of debt and after tax cost of debt are the same.

Answer 1

Question 8 - Option 2

Beta of portfolio is weighted average of the beta of constituents. Beta of risk free asset is 0.

Beta of portfolio = 35% * 1.2 + 35% * 1.1 + 30% * 0 = 0.42 + 0.39 = 0.81

Question 12 - Option 1

Cost of debt (after tax) = Pretax cost * (1 - Tax) = 10% * (1 - 35%) = 6.50%

This is less than the cost of preferred stock. So preferred stock is expensive than debt.

Question 13 - Option 2

After tax cost of debt is applicable or used as the most relevant concept for calculation of WACC