Answered

Welcome to Westonci.ca, your ultimate destination for finding answers to a wide range of questions from experts. Explore a wealth of knowledge from professionals across different disciplines on our comprehensive platform. Get detailed and accurate answers to your questions from a dedicated community of experts on our Q&A platform.

The total market value of the equity of ITM is $6 million, and the total value of its debt is $4
million. The treasurer estimates that the beta of the stock currently is 1.2 and that the expected
risk premium on the market is 10%. The Treasury bill rate is 4%, and investors believe that
ITM’s debt is essentially free of default risk.
a. What is the required rate of return on ITM stock?
b. Estimate the WACC assuming a tax rate of 40%.
c. Estimate 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 glasses.The beta
of optical manufacturers with no debt outstanding is 1.4. What is the required rate of return on
ITM’s new venture? (Assume that the risky project will not enable the firm to issue any
additional debt.)

Sagot :

Answer:

a. The required rate of return on Okefenokee stock is 16%.

b. WACC = 10.56%.

c. Estimate the discount rate for an expansion of the company's present business.

It should be the same as the WACC = 10.56%

d. The required rate of return on Okefenokee's new venture is Ke = 18 %.

Explanation:

Here the given is,

E = $6 million, D = $4 million, Beta = 1.2,

Rmp = the expected risk premium on the market =10%.

Rf = The Treasury bill rate = 4%

a. The required rate of return on Okefenokee stock,

[tex]Ke = Rf + Beta \times Rmp = 4 + 1.2 \times 10 = 16%[/tex]%.

b. Tax rate, T = 40%

The proportion of debt =[tex]Wd = D / (D + E) = 4 / (6 + 4) = 0.4[/tex]

Proportion of equity, We = 1 - Wd = 1 - 0.4 = 0.6

Cost of debt, Kd = Risk-free rate as debt is free of default = 4%

[tex]WACC = Wd \times Kd \times (1 - T) + We\times Ke\\\\ = 0.4 \times4\times (1 - 40) + 0.6 \times 16\\\\ = 10.56%[/tex]

WACC = 10.56%.

c. Estimate the discount rate for an expansion of the company's present business.

It should be the same as the WACC = 10.56%

d. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is 1.4. What is the required rate of return on Okefenokee's new venture? (You should assume that the risky project will not enable the firm to issue an additional debt)

[tex]Ke = Rf + Beta \times Rmp\\\\Ke = 4 + 1.4 \times 10 = 18%[/tex]

Ke = 18 %.

Your visit means a lot to us. Don't hesitate to return for more reliable answers to any questions you may have. Thank you for choosing our platform. We're dedicated to providing the best answers for all your questions. Visit us again. We're glad you chose Westonci.ca. Revisit us for updated answers from our knowledgeable team.