Which of the following statements is most correct?
A) Beta measures market risk, but if a firm's stockholders are not well diversified, beta may not accurately measure stand-alone risk.
B) If the calculated beta underestimates the firm's true investment risk, then the CAPM method will overestimate rs.
C) The discounted cash flow method of estimating the cost of equity can't be used unless the growth component, g, is constant during the analysis period.
D) An advantage shared by both the DCF and CAPM methods of estimating the cost of equity capital, is that they yield precise estimates and require little or no judgement.
E) All of the statements above are false.

Question

Quizplus · Accepted Answer

Beta measures market risk, but it assumes that a stockholder is well diversified. If a stockholder is not well diversified, the stockholder is exposed to additional stand-alone risk that is not captured by beta. Therefore, beta may not accurately measure stand-alone risk. The other statements are false. The CAPM method will underestimate rs if the calculated beta underestimates the firm's true investment risk. The growth component, g, does not need to be constant for the discounted cash flow method to be used. Neither the DCF nor the CAPM method yield precise estimates without any judgement.

Which of the Following Statements Is Most Correct