Boutique Booksellers is considering expanding each of its five shops to include a gourmet coffee shop. It has identified Javabean, a firm that is solely in the gourmet coffee shop business, as a possible acquisition. Javabean's market-beta is 1.25, and Boutique's market-beta is 1.60. The relevant risk-free rate is 3% and the risk premium is 7%. If Boutique decides to make the acquisition, 15% of its funds would be invested in gourmet coffee operations, and 85% would remain invested in its basic bookstore operation.
-Refer to the information above. All else equal, if the acquisition occurs, what return should Boutique require on projects coming out of its gourmet coffee division?

Question

Quizplus · Accepted Answer

The required return on the gourmet coffee division can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + (Beta * Market Risk Premium). Given Javabean's beta is 1.25, the risk-free rate is 3%, and the market risk premium is 7%, the calculation is as follows: Required Return = 3% + (1.25 * 7%) = 3% + 8.75% = 11.75%.

Boutique Booksellers Is Considering Expanding Each of Its Five Shops