Maximizing Shareholder Wealth and Risk-Return Relationship

Maximizing Shareholder Wealth

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Question

If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true?

Answers

A. If the beta of the asset is greater than the corporate beta prior to the addition of that asset, then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.

B. If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm.

C. None of these answers are true.

D. If the beta of an asset is larger than the corporate beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.

E. If the beta of the asset is larger than the firm's beta, then the required return on the asset is less than the required return on the firm.

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Explanations

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A. B. C. D. E.

An increase in a project's beta will cause its stock price to decrease unless the increased beta were offset by a higher expected rate of return. Therefore, high-risk investments require higher rates of return, whereas low-risk investments require lower rates of return.

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