There are two firms that have historically competed in the ice cream industry - Firm A and Firm B. Calculate the cost of capital for each of the firms with the information given below:
|
Firm A
|
Firm B
|
Cost of Debt
|
4%
|
4%
|
Cost of Equity
|
See below
|
See below
|
Risk Free Rate
|
3%
|
3%
|
Beta
|
1.3
|
1.3
|
Market Rate
|
11%
|
11%
|
Weight of Debt
|
40%
|
60%
|
Weight of Equity
|
60%
|
40%
|
Tax rate
|
35%
|
35%
|
Calculate the cost of equity for the two firms (note: they will be the same)
Calculate the corporate cost of capital for the two firms (note: they will be different)
What does the difference in the CCC%u2019s tell us about the riskiness of the two firms? Why is that the case?
If the expected industry return is 8%, will both firms stay in the industry?
If the CCC for each firm remains the same, what should the expected return of the industry eventually approach? Why?