Question

1) The total market value of the common stock of the Okefenokee Real Estate Company is $8.5 million, and the total value of its debt is $6.3 million. The treasurer estimates that the beta of the stock is currently 1.4 and that the expected risk premium on the market is 7%. The Treasury bill rate is 3%. Assume for simplicity that Okefenokee debt is risk-free and the company does not pay tax.

1. What is the required return on Okefenokee stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
2. Estimate the company cost of capital. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
3. What is the discount rate for an expansion of the company's present business? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
4. Suppose the company wants to diversify into the manufacture of rose-colored spectacles. The beta of unleveraged optical manufacturers is 0.90. Estimate the required return on Okefenokee's new venture. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

2) A company is 34% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company’s common stock is 0.65.

What is the after-tax WACC, assuming that the company pays tax at a 30% rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

1.
=3%+1.4*7%=12.80%

2.
=(8.5*12.80%+6.3*3%)/(8.5+6.3)
=8.6284%

3.
=8.6284%

4.
=3%+0.90*(1+6.3/8.5)*7%
=13.9694%

5.
=34%*10%*(1-30%)+66%*(10%+0.65*8%)
=12.4120%