AAA Co is invested in two industries, the P Industry and the Q Industry. It has two divisions, the P division and the Q division, neither of which have traded shares.

P division has an attributed debt of $15MM financing assets of market value $30MM.

Q division has an attributed debt of $2MM financing assets of market value $20MM.

To calculate appropriate divisional costs of capital it is established that comparable traded firms in the Q industry support an average of 10% Debt to 90% Equity, and have asset betas of 1.0, whereas comparable firms in the P industry support an average of 30% Debt to 70% Equity, and have stock betas of 1.0.

The risk-free rate is estimated at 4%p.a. The tax rate is 35%. Firms in both divisions have an implied interest rate of 6%p.a. on borrowings. The 'market risk premium' is estimated as 5%p.a.

Answer rating: 100% (QA)

To calculate the appropriate divisional costs of capital for the P division and the Q division we ne... View the full answer