8. Stevenson-Kwo's Cost of Equity. Senior manage- ment at Stevenson-Kwo is actively debating the implications of diversification on its cost of equity. Although both parties agree that the company's returns will be less correlated with the reference market return in the future, the financial advisers

believe that the market will assess an additional 3.0% risk premium for "going international" to the basic CAPM cost of equity. Calculate Stevenson- Kwo'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.

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Before After Symbol Diversification Diversification Debt to capital ratio DIV 38% 32% Equity to capital ratio E/V 62% 68% Corporate tax Fate 35% 35% Correlation of S-C's returns with market Pjm 0.88 0.76 Standard deviation of S.C's returns 28.0% 26.0% Standard devia- tion of market's returns 18.0% 18.0% Market risk premium 5.50% 5.50% Corporate cost of debt 7.20% 7.00% Risk-free rate of interest 3.00% 3.00%