Wizard Co. currently has only a real estate division and uses only equity capita

Question

Wizard Co. currently has only a real estate division and uses only equity capital; however, it is considering creating consulting and distribution divisions. Its beta is currently 1.1. The risk-free rate is 2.8%, and the market-risk premium is 5.2%. ? 2.80% 8.52% 5.6096 ? 5.88% This means that the firm's real estate division will have a cost of capital of: The consulting division is expected to have a beta of 2.2, because it will be riskier than the firm's real estate division. 16.74% ? 14.24% O 15.59% 15.199% This means that the firm's consulting division will have a cost of capital of:

Explanation / Answer

Answer a.

Risk-free Rate = 2.80%
Beta = 1.10
Market Risk Premium = 5.20%

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 2.80% + 1.10 * 5.20%
Cost of Capital = 8.52%

The firm’s real estate division will have a cost of capital of 8.52%

Answer b.

Risk-free Rate = 2.80%
Beta = 2.20
Market Risk Premium = 5.20%

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 2.80% + 2.20 * 5.20%
Cost of Capital = 14.24%

The firm’s consulting division will have a cost of capital of 14.24%

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