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Wish Industries plans to produce and sell an ornamental lamp
Wish Industries plans to produce and sell an ornamental lamp. After careful consideration, they have decided that Lanternfish Limited's business operations are comparable in riskiness to the lamp project. You have collected the following information: Lanternfish Limited Current Dividend Beta Debt Bond Ratings Total Assets Current Assets Payout Ratio $3.60 1.20 50 Million AAA 350 Million 40 Million 20% Financial Market Information Risk free interest rate Expected return for S&P 500 Dow Jones Industrial Average Unemployment Rate 3.7% 12.0% 26,400 8.5% Estimate the cost of capital for the ornamental lamp project.
Expert Solution
Cost of equity = Risk free return + beta(Market return - Risk free return)
Here Risk free return = 3.7%
Market return = 12%
Beta = 1.2 as risk of lamp project is same as risk of business operation of lanternfish Ltd
Thus Cost of capital = 3.7% + 1.2(12% - 3.7%)
= 3.7% + 1.2(8.3%)
= 3.7% + 9.96%
= 13.66%
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