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You work for the firm and management is considering expanding into a completely new line of business. The financial manager has asked you to determine an appropriate WACC for an average-risk project in the expansion division. You find two publicly traded stand-alone firms that produce the same products in this new division. The average of the two firms' betas is 1.25. Further, you determine that the expected return on the market portfolio is 13% and the risk-free rate of return is 4.%. The firm finances 50% of its projects with equity and 50% with debt and has a before-tax cost of debt of 9% and a corporate tax rate of 30%.
Required:
Problem i. Determine the firm's cost of equity using the SML approach.
Problem ii. Determine the WACC for the new line of business?
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