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Suppose Mr. Palmer, a financial manager of a company, is trying to estimate the cost of capital using the APT for his co...

Suppose Mr. Palmer, a financial manager of a company, is trying to estimate the cost of capital using the APT for his company, Pork Products. He decides that three promising factors would be (i) the return on S&P 500 index; (ii) the 10-year T-bond yield, and (iii) the price of hogs, which are particularly important to his company. His plan is to find the beta of Pork Products against each of these factors using a multiple regression and to estimate the risk premium with each factor. What do you think about his choice of factors?

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Answer #1

His choice of factors is appropriate, given that the company deals in pork products.

The return on S&P 500 index and the 10-year T-bond yield are generic in nature, and can be applied to any business to estimate the beta and risk premium in order to find the cost of capital.

Given that the company is into pork products, the price of hogs would have a direct impact on the cost of capital. Hence, the application of this factor to estimate the cost of capital is appropriate in this case.

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