Question $5[5$ marks$]$

General Engineering is a privately held conglomerate firm consisting of five divisions. The firm is considering starting a grocery store business $$GE Food$.$ Table below summarizes the selected data for other conglomerate firms and grocery chain operators listed in the major stock exchanges.

Equity beta Leverage ratio Unlevered asset beta

Diversified conglomerate firms:

Virgin Group $1\mathrm{.}54\mathrm{.}401\mathrm{.}10$

Imperial Group $1\mathrm{.}30\mathrm{.}001\mathrm{.}30$

Tristar Corp $1\mathrm{.}92\mathrm{.}501\mathrm{.}20$

Conglomerate average $1\mathrm{.}591\mathrm{.}20$

Grocery chain operators:

Kroger $2\mathrm{.}57\mathrm{.}601\mathrm{.}40$

Safeway $1\mathrm{.}55\mathrm{.}101\mathrm{.}45$

Walmart $1\mathrm{.}96\mathrm{.}401\mathrm{.}50$

Grocery store average $2\mathrm{.}021\mathrm{.}45$

Answer questions a$)$ and b$)$ below. $($Lecture notes pp$\mathrm{.}27-32,$ pp$\mathrm{.}37-40)$

a$)$ Determine the CAPM beta that is appropriate to use in calculating the unlevered cost of capital for GE Food and provide a justification for your choice $($approx$.100$ words$).$

Answer $($with a brief discussion to justify your answer$)$:

b$)$ Suppose that GE Food requires a total capital infusion of $$130$ million, which will be financed through a new debt issue of $$50$ million and a new equity issue of $$80$ million. Assume that GE Food will face a marginal tax rate of $20\%.$ Its debt beta is estimated at $0\mathrm{.}25.$ The risk$-$free rate is $5\%$ and the market risk premium is $8\%.$ Find the cost of equity and cost of debt for GE Food.

Answer $($show the steps$/$calculation toward your results$)$: