Question

Newtown Propane currently has only a wholesale division and uses only equity capital; however, it is considering creating marketing and retail divisions. Its beta is currently 1.5. The marketing division is expected to have a beta of 2.2, because it will have more risk than the firm’s wholesale division. The retail division is expected to have a beta of 0.7, because it will have less risk than the firm’s wholesale division. The risk-free rate is 2.8%, and the market risk premium is 5.8%. Based on this information, fill in the missing cost of capital information below:

Wholesale division ?

Marketing division ?

Retail division?

Answer 1

Wholesale Division:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 2.80% + 1.50 * 5.80%
Cost of Capital = 2.80% + 8.70%
Cost of Capital = 11.50%

Marketing Division:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 2.80% + 2.20 * 5.80%
Cost of Capital = 2.80% + 12.76%
Cost of Capital = 15.56%

Retail Division:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 2.80% + 0.70 * 5.80%
Cost of Capital = 2.80% + 4.06%
Cost of Capital = 6.86%