"Corporate finance"exercise:Cost of Capital
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Questions 1:
Which of the following scenarios can best be described as offering superior protection of shareholder interests?
A 、When common law is practiced
B、 When CEO duality is common
C、 When stakeholder theory prevails
Questions 2:
Which method of calculating the firm’s cost of equity is most likely to incorporate the long-run return relationship between the firm’s stock and the market portfolio?
A 、Capital asset pricing model
B 、Dividend discount model
C、 Bond yield plus risk premium approach
A is correct. Unlike civil law systems, common law systems provide judges with the ability to create law by setting precedents that are followed in subsequent cases. Shareholders are viewed as better protected under common law because judges may rule against management actions in situations that are not specifically addressed by statutes.
B is incorrect. Under CEO duality, the CEO also serves as chairperson of the board. All else equal, this decreases the protection of shareholder interests in favor of those of management.
C is incorrect. Stakeholder theory incorporates the interests of non-shareholders such as customers, suppliers, and employees. This inevitably dilutes the focus on shareholders.
A is correct. The capital asset pricing model uses the firm’s equity beta, which is computed from a market model regression of the company’s stock returns against market returns.
B is incorrect. Dividend discount model estimates the equity risk premium by adding the dividend yield and the growth rate in dividends.
C is incorrect. Cost of equity under this method is the additional of cost of debt and risk premium (the additional yield on a company’s stock relative to its bonds)
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