Estimate the cost of equity appropriate for the evaluation of the incremental cash flow associated with the Collinsville investment. Estimate the weighted average cost of capital appropriate for discounting the Collinsville plant´s incremental cash flow.
Before we start calculating the cost of equity we have to make some assumptions about the market.
Beta. In this case we are selling a factory which has only one objective, to manufacture Sodium Chlorate. Therefore we cannot use the beta that is rated on Dixon because they manufacture other chemistry products. To determine the beta for the factory we take a look at two others factory that manufacture only Sodium Chlorite. The companies are Brunswick Chemical, which have the beta 1,1 and Southern Chemicals, which have the beta 1,2. We take the average for these two companies and get 1,15. We decide to use this beta in our calculations.
Risk free rate. It is normally argued to use the short time Treasury bills to estimate the risk free rate and we decided tu use it in our calculations. The short time Treasury rate is 10,5 %
Market risk. The market risk we can calculate because we know the risk premium which is 7,5 % Risk premium =(Rm-Rf)
7,5 = (X – 10,5) => X = 10,5 + 7,5 => 18 %
Cost of equity.
The formula to calculate the cost of equity is: E(R)= Rf+ ß (Rm-Rf)
E(R)= 10,5%+1,15 (18%-10,5%) => 19,125 %
We have calculated that the Cost of equity is 19,125. That is the expected return we will get on our bæta við einhverju hérna
Weighted average cost of capital.
To calculate the weighted average cost of capital we have to make some assumptions. Cost of equity we have already calculated when we found the cost of equity. Cost of debt we assume is the long-term corpor ...