1. A firm’s return on assets (ROA) decreased during a year in which its net profit margin and its return on equity (ROE) increased. Explain what must have happened to the firm’s asset turnover and equity multiplier.
2. A capital investment project is expected to generate an incremental increase in revenues of $15 million and an incremental increase in operating costs of $10 million during its first year. Year 1 incremental depreciation expense is $5 million. The firm’s interest expense will increase by $2 million during year 1. If the firm’s marginal tax rate is 35% what is the year 1 incremental after-tax cash flow for capital budgeting purposes?
3. Joe Jones, Inc. has a beta of .85. The risk-free rate is 5% and the expected rate of return on the market portfolio is 10%.
a. Compute the required return for Joe Jones using the security market line (SML) equation.
b. What is “beta” Under what rationale is beta an appropriate measure of risk?