(rE, and WACC) The current risk-free rate is rf

= 4%, and the expected rate of return on the market portfolio is E r( ) M = 10%. The Brandywine Corporation has two divisions of equal market value. The debt-to-equity ratio of the company is 3/7, and the company’s bonds are risk-free. For the last few years, the Brandy division has been using a discount rate of 12% in capital budgeting decisions, and the Wine division a discount rate of 10%. You have been asked by their managers to report on whether these discount rates are properly adjusted for the risk of the projects in the two divisions. The tax rate is 35%.

a. What are the equity betas of typical projects implicit in the discount rates used by the two divisions?

b. You estimate that the stock beta of the Korbell Brandy Corp. is 1.8.

Korbell is purely in the brandy business, its debt-to-equity ratio is 2/3, and its bond beta is 0.2. Korbell is subjected to the same tax rate as Brandwine. Based on this information (and on your estimate of Brandywine’s stock beta), what discount rate would you recommend for projects in the Brandy and in the Wine divisions of Brandywine?