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Alika [10]
2 years ago
10

I am buying a firm with an expected perpetual cash flow of $1,000 but am unsure of its risk. If I think the beta of the firm is

.5, when in fact the beta is really 1, how much more will I offer for the firm than it is truly worth
Business
1 answer:
Leno4ka [110]2 years ago
3 0

Answer:

Assuming that the risk free rate is 5%, you will pay $4, 849 more

Explanation:

The beta of a company or firm is a measure of the volatility, or systematic risk of a security, as it compares to the market. The beta of a frim or company is a measure of how the company’s equity market value changes with the changes in the overall market. It shows the sensitivity of the company’s equity to changes in the market. Systematic risk is the risk that cannot be diversified. This type od risk is due to changes in the market, and because of this, it cannot be avoided. This risk is caused by factors that are external to the firm.

Assume that the $1, 000 is a perpetuity. The risk- free rate is 5%

If beta is 5, the cash flow is discounted at 55%  

PV (beta = 5) = $1, 000 / .55 = $1, 818

If, however, beta is equal to 1, the investment will yield at 15%, and the price paid for the firm should be:

PV = $1, 000 / .15 = $6, 667

The difference $4, 849 [ $6, 667 - $1, 818], is the amount you will pay if you erroneously assumed that the beta is 5 rather 1.

If the cash flow lasts only one year:

PV (beta = 5) = $1, 000 / (1 + .55) = $645

PV (beta = 1) = $1, 000 / (1 + .15) = $869

With a difference of $224.

Incorrectly assuming the value of beta has substantial effects on the calculations of cash flows.

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$778.05625

Explanation:

The computation of the amount of repayment is shown in the attachment below:

Given that

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= Principal of the loan amount ÷ Total annuity

= $10,000 ÷ 12.85254119

= $778.05625

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3 0
3 years ago
Suppose Hoosiers, a specialty clothing store, rents space at a local mall for one year, paying $13,800 ($1,150/month) in advance
tigry1 [53]

Answer:

1.

Dec 31    Rent expense                   $3450 Dr

                  Prepaid Rent                       $3450 Cr

2.

Oct 1     Prepaid Rent                        $13800 Dr

                  Cash                                       $13800 Cr

3.

Year end balances at 31 December:

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Prepaid Rent = $10350

Explanation:

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1.

The rent is paid in advance thus it is an asset. On 31 December the adjusting entry will be made under the accrual principle to match the current period's rent expense and record it in the period to which it belongs to. Thus we will credit the rent expense for 3 months i.e. October, November and December. We will credit the asset account that is Prepaid Rent.

2.

The prepayment of rent is creating an asset account in the title of prepaid rent. The entry would be to record the asset prepaid rent by the full amount of the rent prepaid and credit the other asset account through which the payment is being made.

3.

The adjusted year end balance for rent expense will be the rent expense paid for this period that is $1150 * 3 = 3450

The balance in the prepaid rent account after adjusting the rent expense will be,

Prepaid rent = 13800 - 3450 = $10350

8 0
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