Module 4: Long Answer Questions

For students

Last updated: 09/01/2026 12:59

The questions are based on or inspired by the following references:

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📘 Part 1 (until Midterm)

Module	Chapter
4	ch12

Answer the following questions based on the discussions in class.

Q1.

Explain the difference between total risk and systematic (market) risk in the context of the Capital Asset Pricing Model (CAPM). Why does only systematic risk affect a company’s cost of equity capital?

Q2.

Describe how a firm can estimate the cost of capital for a new project using comparable companies. What adjustments need to be made if the comparable firms have different capital structures (leverage) than the project? Include in your answer the concepts of unlevered beta and re-leveraging.

Q3.

Discuss the practical challenges in estimating the market risk premium used in CAPM. What are the limitations of using historical averages, and what alternative methods can firms use to estimate the expected market return?

Q4.

Explain the difference between using the CAPM approach versus using bond yields to estimate the cost of debt.

Q5.

Discuss how the use of debt financing impacts a firm’s equity beta. Explain the intuition behind why increasing leverage amplifies the risk to equity holders, even if the firm’s asset beta remains constant.

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