4. Computer Corp currently has assets of $50 million and a beta of 1.4. The risk

Question

4. Computer Corp currently has assets of $50 million and a beta of 1.4. The risk free rate is 7 percent and the market risk premium is 5 percent. Computer Corp would like to expand into a risky home computer market If the expansion is undertaken, Computer Corp would create a new division with $5 million in assets and the new division will have an estimated beta of 1.9. (a) What is Computer Corp's current (without the expansion) required rate of return? (5) b) If the expansion is undertaken, what would be the firm's new beta, new overall required rate of return? (5) _ 4.lt-t 1% -4

Explanation / Answer

Computer Corp. a. What is CCC’s current required rate of return? r = 7% + 5%(1.4) = 14% b.If the expansion is undertaken, what would be the firm’s new beta? What is the new overall required rate of return, and what rate of return must the home computer division produce to leave the new overall required rate of return unchanged? Beta = 1.4*50m/(50+5)m + 1.9*5m/(50+5)m = 1.45 r_new = 7% + 1.48*5% = 14.4% r_division = 7% + 1.9*5%= 16.5%.

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