You own a private company that has two completely distinct divisions. You have chosen to run your company with absolutely no debt. You want to estimate your company's current cost of capital.

The first division is in the consumer electronics market. It represents what you believe to be 70% of the value of your company. You have identified a publicly traded company that is similar to this division, but note that it has debt/equity of 20% (at market values) and a tax rate of 30%. Your tax rate is 40%. The public comparable has a Beta of 1.2.

The second division provides design, installation and maintenance services. It represents the other 30% of the value of the company. You have identified a separate publicly traded company similar to this division, but note that it has a debt/equity ratio of 40% (at market values) and a tax rate of 40% (the same as yours). It has a Beta of 1.0.

The risk free rate is 2.00%. You decide to use a market risk premium of 6%.

a) What is the appropriate Beta for each division? (Hint: Use the Hamada equation.)

b) What is the cost of capital for each division?

c) What is the cost of capital for the entire company?

d) Should you use the corporate cost of capital to evaluate all projects for this company? Why or why not?

Answer rating: 100% (QA)

Calculating Cost of Capital for a TwoDivision Company a Beta for each division We can use the Hamada ... View the full answer