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Okefenokee Real Estate Co: What is the required return on stock, cost of capital, and discount rate?

The total market value of the common stock of the Okefenokee Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock is currently 1.5 and that the expected risk premium on the market is 6 percent. The Treasury bill rate is 4 percent. Assume for simplicity that Okefenokee debt is risk-free and the company does not pay tax.

a. What is the required return on Okefenokee stock?
b. Estimate the company cost of capital.
c. What is the discount rate for an expansion of the company's present business?
d. Suppose the company wants to diversify into the manufacture of rose-colored spectacles.

The beta of unleveraged optical manufacturers is 1.2. Estimate the required return on Okefenokee's new venture.

Solution Preview

The total market value of the common stock of the Okefenokee Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock is currently 1.5 and that the expected risk premium on the market is 6 percent. The Treasury bill rate is 4 percent. Assume for simplicity that Okefenokee debt is risk-free ...

Solution Summary

This solution provides calculations and explanation for the required return on Okefenokee stock, cost of capital (WACC), discount rate, and required return for the new venture.

$2.19