3. If the proxy companies are used in a CAPM approach, it is clear that different systematic risks are involved in the two divisions. The proxy companies in the health food business have more debt than Novus Nyet Company. In this case, the beta probably should be adjusted for leverage, using the technique presented in the chapter. The beta in the absence of leverage would be where (.50/.50) is the debt-to-equity ratio. The adjusted beta for the proportion of debt Novus Nyet employs in its division is Adjusted P = ,5625 1 + - (1 - [ : .4) ] = .7071 or, with rounding, .71. Given an adjusted proxy beta of .71 for health foods and a proxy beta of 1.25 for specialty metals, the required returns on equity become Required Equation Equity Return Health Foods 6% + (5%).71 9.55%

Special@ Metals 6% + (5%)1.25 12.25 The after-tax cost of debt funds for both divisions is 8%(1 - .4) = 4.80%. The weighted average required return for each division becomes Debt Equity Weighted Average Cost Weight Cost Weight RequiredReturn Health Foods 4.80 .3 9.55 .7 8.13%

Specialh. Metals 4.80 .3 12.25 .7 10.02 Chapter 8 Creating Value through Required Returns 239 The figures in the last column would be used as minimum, or required, returns for the two divisions.