The total market value of Okefenokee Real Estate Company\'s equity is $4 million

Question

The total market value of Okefenokee Real Estate Company's equity is $4 million, and the total value of its debt is $1 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 8%. The Treasury bill rate is 4%.

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 $4 million, and the total value of its debt is $1 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 8%. The Treasury bill rate is 4%.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Required Rate of Return = Risk Free Rate + Beta*(Risk Premium) = 4 + .5*(8) = 8%

Part B:

Weighted Average Beta = Beta of Debt*Weight of Debt + Beta of Equity*Weight of Equity = 0*1/5 + .50*4/5 = .40

Part C:

WACC = After Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity = 4*(1-.20)*1/5 + 8*4/5 = 7.04%

Part D:

Discount Rate = 7.04% (same as WACC)

Part E:

Revised Required Rate of Return = Risk Free Rate + Revised Beta*(Risk Premium) = 4 + 1.5(*8) = 16%

Thanks.

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