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    Risk and Cost of Capital

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    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

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