The total market value of the common stock of the Okefenokee Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock is currently 1.5 and that the expected risk premium on the market is 6%. The Treasury bill rate is 4%. Assume for simplicity that Okefenokee debt is risk-free and the company does not pay tax.

a. What is the required return on Okefenokee stock?

b. Estimate the company cost of capital.

c. What is the discount rate for an expansion of the companys present business?

d. Suppose the company wants to diversify into the manufacture of rose-colored spectacles. The beta of unleveraged optical manufacturers is 1.2. Estimate the required return on Okefenokees new venture.

i. Calculate the discount rate for the new venture if Okefenokee only uses an increase in retained earnings to finance the new venture.

ii. Calculate the opportunity cost of equity capital if Okefenokee finances 40% of the new venture using new debt (same cost as existing debt) and the remaining 60% using an increase in retained earnings. Calculate the discount rate for the new venture.

iii. Repeat (ii), assuming Okefenokee now needs to pay corporate tax rate of 26%.