17: Cost of Capital

Question 1

General risk premium covering unique risks of a private company:
key-person risk, geographical, etc.

Answer 1

Specific company risk premium

Question 2

International CAPM (ICAPM) is made up of two factors:

Answer 2

Factor 1: captures the company’s relationship with the local economy, relative to the global economy
Factor 2: captures the sensitivity of the company’s cash flows to changes in its currency value

Question 3

Companies in countries with tax systems that favor interest income, vs dividends will have (higher or lower) leverage?

Answer 3

Higher financial leverl, more debt in their capital structures

Favor meaning they are taxed at a lower rate

Question 4

Higher inflation has what affect on financial leverage?

Answer 4

Financial leverage will be lower

High inflation reduces the value of fixed interest payments to investors

Question 5

With backfill & survivorship bias, the unadjusted equity risk premium is biased: (upward or downward)

Answer 5

Upward

Question 6

With failure to incorporate the return from dividends, the unadjusted equity risk premium is biased: (upward or downward)

Answer 6

downward

Question 7

When short term interest rates are high, the required return on equity is expected to be biased (upward or downward)

Answer 7

Upward

As a result of a normal upward sloping yield curve

Question 8

Shadow banking systems rely on:

Answer 8

unregulated, non-bank sources

Question 9

In less developed countries that lack corporate debt markets, businesses have to rely on:

Answer 9

bank lending
or
Shadow Banking

Question 10

Countries that follow common law, offer____ vs civil law

Answer 10

Common law: stronger protection, leading to lower risk premiums