BU393 Chapter Notes - Chapter 13: Preferred Stock, Adverse Selection, Weighted Arithmetic Mean

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24 Jan 2014
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The discount rate of a project should be the expected return on a financial asset of comparable risk. The expected return is the cost of equity capital. To estimate a firm"s cost of capital, we need: The beta of a stock is determined by the characteristics of the firm. If the firm is not traded on an exchange because it is a subsidiary of a larger firm or too small to be listed, examining these characteristics may be the best way to estimate beta. Some firms do well in the expansion phase of the business cycle and poorly in the contraction phase. Stocks with high standard deviations need not have high betas. The difference between variable costs and fixed costs allows us to define operating leverage. The cyclicality of a firm"s revenues is a determinant of the firm"s beta. Operating leverage magnifies the effect of cyclicality on beta.

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