Unformatted text preview: capital budgeting decision has been made. l. Harry Davis is interested in establishing a new division, which will focus primarily on developing new internet-based projects. In trying to determine the cost of capital for this new division, you discover that stand-alone firms involved in similar projects have on average the following characteristics: • Their capital structure is 10 percent debt and 90 percent common equity. • Their cost of debt is typically 12 percent. • The beta is 1.7. given this information, what would your estimate be for the division’s cost of capital? Answer: r s DIV. = r RF + (r M- r RF )b DIV. = 7% + (6%)1.7 = 17.2%. WACC DIV. = w d r d (1 - T) + w c r s = 0.1(12%)(0.6) + 0.9(17.2%) = 16.2%. The division’s WACC = 16.2% vs. The corporate WACC = 11.1%. The division’s market risk is greater than the firm’s average projects. Typical projects within this division would be accepted if their returns are above 16.2 percent....
View Full Document
This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
- Spring '08
- Cost Of Capital