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As the assistant to the Chief Financial Officer of Lily Co

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As the assistant to the Chief Financial Officer of Lily Co., you are asked to help evaluate new investment opportunities. Followings are some information gathered already: - The current weighted average cost of capital for Lily Co. is 12% - Lily Co. currently has a capital structure with 24% debt and 76% equity - Lily Co. plans to invest in a project which is different to its existing business operations, and has identified a company in the same business area as the project, Rose Co.. The equity beta of Rose Co. is 1.6 and the capital structure of Rose is 50% debt and 50% equity - The tax rate is 20% - The yield on a 20-year treasury bond is 6% and the expected return on the stock market is 13%. Please answer the following questions:

(1). Calculate the cost of equity which could be used in appraising the new project for Lily Co. (6 marks)

(2). The equity beta captures the market risk rather than the diversifiable risk. Please explain the difference between diversifiable risk and market risk. (4 marks)