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Hi sir,
I just wonder the reason why 6 (2) ,7(3), 18 (2) in June 2015 are wrong.Question 6:
The actual outcome will be one of the various possibilities. The expected value is simply a weighted average which is unlikely to be one of the actual possibilities.
For example if there is a 50% probability of the outcome being 100 and a 50% probability of being 50. Then it will either be 100 or it will be 50 – it will certainly not be the expected value of 75.
Question 7
The only way to be convinced it to try some numbers yourself.
If the beta of debt is more than zero (which it will be in real life, even though it will be low). Then using the asset beta formula if we know the asset beta will end up giving a lower equity beta that when the debt beta is zero. So assuming debt beta is zero understates the equity beta which therefore understates the financial (gearing) risk.Question 18:
Operational efficiency means that the workings of the capital markets is efficient (e.g. that the buying and selling of investments is handled efficiently), which has nothing to do with where the funds are actually being used.
I learn that Q6 describes actual outcome, so it is not ENPV, am I right?
Q7 I am confused because beta of debt is not relevant in beta asset formula.What does UNDERSTATE mean in Q7?I hope that you will not use abbreviations such as ENPV in the exam!! It is not a standard abbreviation 🙂 You should write ‘expected NPV’.
Again, the actual outcome is not usually going to be the same as the expected outcome.
Look again at my example.Q7 Of course the debt beta is relevant in the formula!!! Look again at the formula on the formula sheet that is given in the exam. We always assume in calculations for F9 that the debt beta is zero and therefore has zero risk. In real life, debt is never completely risk free and therefore the debt beta will not be zero.
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