Production Unlimited has an overall beta of.92 and a cost of equity of 10.8 % for the firm overall. The firm is 100 % financed with common stock. Division A within the firm has an estimated beta of 1.47 and is the riskiest of all of the firm's operations. What is an appropriate cost of capital for division A if the market risk premium is 6 %?

Question

Quizplus · Accepted Answer

The cost of capital for Division A can be calculated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium. Given that the firm's overall cost of equity is 10.8% and its beta is .92, we can rearrange the CAPM formula to solve for the risk-free rate (Rf). 10.8% = Rf + .92*6%. Solving for Rf gives us a risk-free rate of 4.32%. Using this risk-free rate, we can calculate the cost of capital for Division A as follows: Cost of Capital for Division A = 4.32% + 1.47*6% = 4.32% + 8.82% = 13.14%, which rounds to 14.1%.

Production Unlimited Has an Overall Beta Of