KFC Beef, a fast-food company selling roasted beef in outlets through the country, went public in

1993. In the year prior to going public, it had revenues of $40 million, on which it reported EBIT

of $12 million. The firm had no debt outstanding, and expected revenues to grow 35% a year from

1993 to 1997, 15% a year from 1998 to 2000, and 5% a year after that, while pre-tax operating

margins (EBIT/Revenues) were expected to remain stable. Capital expenditures, which exceeded

depreciation by $5 million in the year prior to going public, were expected to grow 20% a year

from 1993 to 1997, as is depreciation. After 1998, capital expenditures are expected to offset

depreciation. Working capital requirements are negligible.

The average beta of publicly traded fast-food chains with which KFC Beef will be competing is

1.15, and their average debt-equity ratio is 25%. KFC Beef plans to maintain its policy of no debt

until 1997, and to move to the industry average debt ratio after that (the pre-tax cost of debt is

expected to be 8%). The treasury bond rate is 7%. All firms face a tax rate of 40%. The equity risk

premium is 5.5%.

A. Estimate the cost of equity for KFC Beef.