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4. Adjusting the cost of capital for risk Aa Aa Divisional Costs of Capital A firm's cost of capital is often a reflection of its
4. Adjusting the cost of capital for risk Aa Aa Divisional Costs of Capital A firm's cost of capital is often a reflection of its activities and funding needs. Consider the case of Wizard Company, and answer the following questions Wizard Co. currently has only a real estate division and uses only equity capital; however, it is considering creating consulting and distribution divisions. Its beta is currently 1.2. The risk-free rate is 4.8%, and the market-risk premium is 6.7% 4.80% 9.60% O 10.56% 12.84% This means that the firm's real estate division will have a cost of capital of: The consulting division is expected to have a beta of 1.8, because it will be riskier than the firm's real estate division 19.36% 17.81% 16.86% 18.21% This means that the firm's consulting division will have a cost of capital of: The distribution division will have less risk than the firm's real estate division, so its beta is expected to be 0.8 O 18.81% 18.91% 10.16% 17.61% This means that the distribution division's cost of capital will be: Wizard Co. expects 60% of its total value to end up in the real estate division, 25% in the consulting division, and 15% in the distribution division 16.29% 13.44% 14.74% 18.19% Based on this information, what rate of return should its investors require once it opens the new divisions
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