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 Asset beta

Diversified conglomerate firms:

Virgin Group 1.54 .40 1.10

Imperial Group 1.30 .00 1.30

Tristar Corp 1.92 .50 1.20

Conglomerate average 1.59 1.20

Grocery chain operators:

Kroger 2.57 .60 1.35

Safeway 1.55 .10 1.45

Walmart 1.96 .40 1.40

Grocery store average 2.02 1.40

Answer questions a) and b) below. (Lecture notes pp.27-32, pp.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. 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 0.2. The risk-free rate is 7% and the market risk premium is 6%. Find the cost of equity and cost of debt for GE Food. Answer (show the steps/calculation toward your results):