Arbitrage Pricing Theory
1. Compare the assumptions underlying Arbitrage Pricing Theory with those underlying the mean-variance Capital Asset Pricing Model. Which set of assumptions seems more realistic to you? Why?
2. Show how the following events change the discount rate applicable to an expansion of an existing restaurant chain.
The covariance between restaurant sales and the market rate of return increases.
The riskless rate decreases
Several other companies are planning to expand their chains
3.Which of the following companies is likely to have a higher beta, and thus a higher cost of capital ?
- An auto manufacturer who runs an assembly line with union workers.
- A « high tech » auto manufacturer with a fully automated line requiring only a handful of nonunion workers.
4. Ampex common stock has a beta of 1.4. If the risk-free rate is 8%, the expected market return is 16%, and Ampex has $20 million of 8% debt, with a yield to maturity of 12% and a marginal tax rate of 50%, what is the WACC for Ampex?