The total market value of Okefenokee Real Estate Company\'s equity is $3 million

Question

The total market value of Okefenokee Real Estate Company's equity is $3 million, and the total value of its debt is $2 million. The treasurer estimates that the beta of the stock currently is 1.1 and that the expected risk premium on the market is 10%. The Treasury bill rate is 5%. What is the required rate of return on Okefenokee stock? What is the beta of the company's existing portfolio of assets? The debt is perceived to be virtually risk free (Round your answer to 2 decimal places.) Estimate the weighted-average cost of capital assuming a tax rate of 30%. (Do not round intermediate calculations Round your answer to 2 decimal places.) Estimate the discount rate for an expansion of the company's present business. (Do not round Intermediate calculations. Round your answer to 2 decimal pieces.) Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta optical manufacture's with no debt outstanding is 1.3. What is the required rate of return on Okefenokee's new venture? (You should assume that the risky project will not enable the firm to Issue any additional debt )

Explanation / Answer

A)

Required rate of return = risk free return + beta * market risk premium

= 5% + 1.1 * 10%

= 16%

B)

WEIGHTED AVERAGE BETA = ( 16% -5% )/ 10% = 1.1

C)

WACC = weight of equity * Cost of equity + weight of debt * Cost of Debt

= 16% * 3/5 + 10% * 2/5

= 13.6%

D) DISCOUNT RATE = 13.65

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