Problem:
The total market value of Okefenokee Real Estate Company's equity is $4 million, and the total value of its debt is $1 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 8%. The Treasury bill rate is 4%.
Required:
Question 1: What is the required rate of return on Okefenokee stock?
Question 2: What is the beta of the company's existing portfolio of assets? The debt is perceived to be virtually risk-free.
Question 3: Estimate the weighted-average cost of capital assuming a tax rate of 20%.
Question 4: Estimate the discount rate for an expansion of the company's present business.
Question 5: Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is 1.5. 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 any additional debt.)
Note: Solve the problem and show all work.