Suppose the total market value of a company is $6 million, and the total market value of its debt is $4 million (the company has no preferred stock). The treasurer estimates that the beta of the stock is currently 1.2 and that the expected risk premium on the market is 10 percent (i.e., RPm = (rmkt %u2013 rrf ) = 10%). The Treasury note rate (rrf) is 4%.
A. What is the required rate of return (rs) on the company%u2019s stock?
B. Estimate the weighted average cost of capital (WACC) assuming a tax rate of 40%.
C. Suppose the company wants to diversify into the manufacture of rose-colored glasses
(a completely new, and more risky, business venture). The beta of optical manufacturers with a similar capital structure is 1.4. What is the required rate of return on the firm%u2019s new venture? (You should assume that this risky project will not require the firm to issue.