10.67% (=2.58/(35)+3.3%) 6.For the problem above, if the flotation cost for new common stock is $1.80, what is the cost of new common stock? 7. S Corporation’s common stock has a beta of .83. The interest rate on 10 year U.S. Treasury bonds is 3.4 percent, and the interest rate on 1 year U.S. Treasury bills is 1.18 percent. Assuming an average market risk premium of 5.0 percent, use the mean-variance capital asset pricing model to estimate the cost of existing common equity for S Corporation. 7.55% (=3.4+.83*5.0) 8. Mark Inc. is a privately held company, so there is no information about beta available. However, a company in the same business with a debt to equity ratio the same as that of Mark Inc. is publicly traded and has a beta of 1.25. If the risk-free rate is 3.8 percent, and the average market risk premium is 5.5 percent, what is the estimated cost of existing equity for Mark Inc.? 10.68% (=3.8+1.25*5.5) 9. If a company has a beta of 1.8 and is considering a low risk project outside its normal course or business with a beta of 1.25, what beta should the company use? The 1.25 or the 1.8? Why? For capital budgeting decisions and analysis, if the beta of the project is different than the beta of the firm, you would always use the beta of the project or 1.25 in this case. This reflects the risk that the project brings to the firm.
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