1.Providence Corporation is not publicly traded. The company has total debt of $1 million and total equity of $1 million. A company with comparable risk characteristics, other than capital structure related risks, has a beta of 1.5. That company has debt of $1 million and equity of $2 million.
Each company has a tax rate of 34 percent. The risk-free rate is 6 percent and the expected return on the market portfolio is 12.5 percent. Estimate the required return on equity for Providence.
2.Dover Corporation is not publicly traded. However, a company that produces the same product has a beta of 1.5 and a debt to equity ratio of .8. The competitor has a tax rate of 34 percent amid pays interest of 8 percent on its debt.
Dover has debt of $1 million and equity of $1.5 million. Dover pays a 34 percent tax rate and pays 7.5 percent interest on its debt. The expected return for the market portfolio is 12.5 percent, and the risk free rate is 6 percent. Compute the cost of equity capital for Dover.