The total market value of Okefenokee Real Estate Company\'s equity is $6 million

Question

The total market value of Okefenokee Real Estate Company's equity is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock currently is 1.5 and that the expected risk premium on the market is 6%. The Treasury bill rate is 5%.

What is the required rate of return on Okefenokee stock?

What is the beta of the company

The total market value of Okefenokee Real Estate Company's equity is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock currently is 1.5 and that the expected risk premium on the market is 6%. The Treasury bill rate is 5%.

Explanation / Answer

Hi,

Please find the answers as follows:

Part A:

Required Return = Risk Free Rate + Beta*(Market Risk Premium) = 5 + 1.5*(6) = 14%

Part B:

Weighted Average Beta = 1.5 (since debt is stated to be completely risk free)

Part C:

WACC = Cost of Debt*(1-t)*Weight of Debt + Cost of Equity*Weight of Equity = 5*(1-.35)*4/10 + 14*6/10 = 9.7%

Part D:

Discount Rate would be same as the cost of capital calculated in Part C = 9.7%

Part E:

Required Return = Risk Free Rate + Beta*(Market Risk Premium) = 5 + 2.5*(6) = 20%

Thanks.

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