Adjusting the cost of capital for risk Newtown Propane currently has only a whol

Question

Adjusting the cost of capital for risk Newtown Propane currently has only a wholesale division and uses only equity capital; however, it is considering creating marketing and retail divisions. Its beta is currently 1.1. The marketing division is expected to have a beta of 2.2, because it will have more risk than the firm's wholesale division. The retail division is expected to have a beta of 0.5, because it will have less risk than the firm's wholesale division. The risk-free rate is 3.1%, and the market-risk premium is 5.2%. Based on this information, fill in the missing information in the following below: If 65% of Newtown Propane's total value ends up in the wholesale division, 25% in the marketing division, and 10% in the retail division, then its investors should require a return of.

Explanation / Answer

Cost of Capital for wholesale division = 3.1% + (5.2%*1.1) = 8.82%

Cost of capital for marketing division = 3.1% + (5.2%*2.2) = 14.54%

Cost of capital for retail division = 3.1% + (5.2%*0.5) = 5.70%

Required Return = (0.65*8.82%) + (0.25*14.54%) + (0.10*5.70%) = 9.938%

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