Question

Coke Products Corp has a risk-free rate of return of 3.4 percent. Their beta is 1.28,...

Coke Products Corp has a risk-free rate of return of 3.4 percent. Their beta is 1.28, and their cost of common stock is equivalent to 13.6%. If they are solely financed with common stock, what is the cost of capital for a division within the firm that has an estimated beta or 1.18?

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Answer #1
As per Capital Asset Pricing Model,
Cost of common stock = Risk Free rate +Beta*Market risk premium
So, first of all we have to calculate market risk premiuim from the given data.
Cost of common stock = Risk Free rate +Beta*Market risk premium
0.136 = 0.034 + 1.28 * market risk premium
0.102 = 1.28 * market risk premium
Market risk premium = 0.079688
Thus, Market risk premium is 7.97%
Now, we have all data to calculate cost of Capital of division having beta of 1.18.
Cost of Capital = Risk Free rate +Beta*Market risk premium
= 0.034 + 1.18 * 0.0797
= 0.034 + 0.094046
= 0.128046
Thus, Cost of Capital of division within firm having beta of 1.18 is 12.80%
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