Bob's Tractor and Party Supply has two separate divisions: party supplies,and tractor supplies and services.The party supply division has a beta of 1.2 and is financed by 25% debt.The tractor supply and service division has a beta of 0.8 and is financed by 60% debt.The cost of debt for each division is 5%.The risk free rate and market rate are 5% and 10% respectively.A project has recently become available for each division with an expected return of 10%.Which division(s)should take on the project?

Question

Quizplus · Accepted Answer

k_e = k_F + β(k_M - k_F) Party Supplies = 0.05 + 1.2(0.10 - 0.05) = 11%. 11% > 10%, so reject Tractor Supply and Services = 0.05 + 0.80(0.10 - 0.05) = 9%. 9% < 10%, so accept

Bob's Tractor and Party Supply Has Two Separate Divisions: Party