Genedak-Hogan Cost of Equity. Senior management at Genedak-Hogan is 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.

Transcribed Image Text:

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