The Green Acres Lawn Company produces and sells lawn care products, such as fertilizers, seeds, and lawnmowers. Its market-beta is 1.30. It is considering diversifying into the manufacture of snowblowers to offset the seasonality of its current product lines. Management has estimated the market-beta for this new line of business to be 1.60. The relevant risk-free rate is 4%, and the market equity risk premium is 7%. Assume that 70% of the business will remain in lawn care products if the firm undertakes this project.
-Refer to the information above. All else equal, what will Green Acres' new cost of equity be if they venture into the snowblower business?

Question

Quizplus · Accepted Answer

The new cost of equity can be calculated using the weighted average beta: New Beta = 0.7 * 1.30 + 0.3 * 1.60 = 1.39. Then, use the CAPM formula: Cost of Equity = Risk-free rate + (New Beta * Market Risk Premium) = 4% + (1.39 * 7%) = 13.73%.

The Green Acres Lawn Company Produces and Sells Lawn Care