# Risk and Cost of Capital

Nero Violins has the following capital structure:

Security Beta Total Market Value ($millions)

Debt 0 $100

Preferred stock .20 40

Common Stock 1.20 299

A. What is the firm's asset beta?

B. Assume that the CAPM is correct. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? Assume a risk-free interest rate of 5% and a market risk premium of 6%.

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#### Solution Preview

A. What is the firm's asset beta?

Total market value of securities=100+40+299=$439 million

Weight of debt=wd=100/439=0.22779

Beta of debt=bd=0

Weight of preferred ...

#### Solution Summary

Solution describes the steps to calculate the asset beta and appropriate discount rate.

$2.19