Wizard Co. currently has only a real estate division and uses only equity capita

Question

Wizard Co. currently has only a real estate division and uses only equity capital; however, it is considering creating consulting and distribution divisions. Its beta is currently 1.3. The risk-free rate is 4.4%, and the market-risk premium is 5.2% ? 10.12% ? 11.16% 4.40% ? 8.80% This means that the firm's real estate division will have a cost of capital of: The consulting division is expected to have a beta of 1.9, because it will be riskier than the firm's real estate division ? 15.23% ? 14.28% ? 15.63% ? 16.78% This means that the firm's consulting division will have a cost of capital of: The distribution division will have less risk than the firm's real estate division, so its beta is expected to be 0.7 ? 16.23% ? 16.33% ? 15.03% ? 8.04% This means that the distribution division's cost of capital will be: Wizard Co. expects 75% of its total value to end up in the real estate division, 10% in the consulting division, and 15% in the distribution division ? 12.30% ? 13.85% ? 15.75% ? 11.00% Based on this information, what rate of return should its investors require once it opens the new divisions?

Explanation / Answer

1.

B

Working note:

Cost of capital = 4.4% + 1.3*5.2%              = 11.16%

2.

B

Working note:

Cost of capital = 4.4% + 1.9*5.2%              = 14.28%

3.

D

Working Note:

Cost of capital = 4.4% + .7*5.2%                 = 8.04%

4.

D

Working note:

Rate of return = .75*11.16% + .1*14.28% + .15*8.04%

Rate of return = 11.00%

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