A firm\'s cost of capital is often a reflection of its activities and funding ne

Question

A firm's cost of capital is often a reflection of its activities and funding needs. Consider the case of Wizard Company, and answer the following questions: 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 1.4. The risk-free rate is 3.6%, and the market-risk premium is 6.2%. O O O 7.20% 3.60% 12.28% 8.64% 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 2.0, because it will be riskier than the firm's real estate division. O O 16.95% 16.00% 17.35% 18.50% 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 0.8. 0 17.95% O 8.56% O 16.75% O 18.05% This means that the distribution division's cost of capital will be:

Explanation / Answer

Answer)

Cost of capital = Risk free rate + Beta * market risk premium

= 3.6%+1.4*6.2%

=12.28%

Answer ) Using the same formulae above and replacing the value of beta with new beta

=3.6% + 2*6.2%

= 16%

Answer)

Using the same formulae above and replacing the value of beta with new beta

=3.6% + 0.8*6.2%

= 8.56%

Answer )

Rate of return = weight of the dividion x Rate of return from the division

Rate of return = 0.65*0.1228 +0.25*0.16+0.10*0.0856 = 0.12838 or 12.84%

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