If the firm is being operated so as to maximize shareholder wealth,and if our basic assumptions concerning the relationship between risk and return are true,then which of the following should be true?
A) If the beta of the asset is larger than the firm's beta,then the required return on the asset is less than the required return on the firm.
B) If the beta of the asset is smaller than the firm's beta,then the required return on the asset is greater than the required return on the firm.
C) If the beta of the asset is greater than the corporate beta prior to the addition of that asset,then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.
D) If the beta of an asset is larger than the corporate beta prior to the addition of that asset,then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.
E) None of the above is a true statement.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the required return of a firm is determined by its beta. If an asset has a higher beta than the firm, it will be more volatile and riskier than the firm, and therefore will require a higher return. Adding such an asset to the firm's portfolio will increase the overall risk of the firm, and hence increase its required return. Therefore, D is the correct statement, and the other statements are false.

If the Firm Is Being Operated So as to Maximize