The total market value of Muskoka Real Estate Company is $6 million and the total value of its debt is $2 million. The treasurer estimates that the beta of the stock is currently 1.5 and that the expected risk premium on the market is 7%. The Treasury bill rate is 4%.
a. What is the required rate of return on Muskoka stock?
b. What is the beta of the company’s existing portfolio of assets? The debt is perceived to be virtually risk-free.
c. Estimate the weighted-average cost of capital assuming a tax rate of 40%.
d. Estimate the discount rate for an expansion of the company’s present business.
e. Suppose the company wants to diversity into the manufacture of rose-coloured glasses. The beta of optical manufacturers with no debt outstanding is 1.2. What is the required rate of return on Muskoka’s new venture?