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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 divisions 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 divisions WACC = 16.2% vs. The corporate WACC = 11.1%. The divisions market risk is greater than the firms average projects. Typical projects within this division would be accepted if their returns are above 16.2 percent....
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- Spring '08
- Cost Of Capital