Genedak-Hogan Cost of Equity. Senior management at Genedak-Hogan are actively debating the implications of diversification on its cost of equity. All agree that the company’s returns will be less correlated with the reference market return in the future, the financial advisors believe that the market will assess an additional 3.0% risk premium for “going international” to the basic CAPM cost of equity. Calculate Genedak-

Hogan’s cost of equity before and after international diversification of its operations, with and without the hypothetical additional risk premium, and comment on the discussion.

Use the table below to answer this problem. Genedak-Hogan is an American conglomerate that is actively debating the impacts of international diversification of its operations on its capital structure and cost of capital. The firm is planning on reducing consolidated debt after diversification.

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Assumptions Symbol Before Diversification After Diversification 0.88 0.76 Correlation between G-H and the market Pjm 28.0% 26.0% Standard deviation of G-H's returns j 18.0% 18.0% Standard deviation of market's returns Risk-free rate of interest Krf 3.0% 3.0% Additional equity risk premium for internationalization RPM 0.0% 3.0% Estimate of G-H's cost of debt in U.S. market kd 7.2% 7.0% Market risk premium km - krf 5.5% 5.5% t 35.0% 35.0% Corporate tax rate Proportion of debt Proportion of equity DIV 38% 32% EIV 62% 68%