Arizona Rock, an all-equity firm, currently has a beta of 1.25. The risk-free rate, rRF, is
7% and the market risk premium, RPM, is 7%. Suppose the firm sells 10% of its assets
with beta equal to 1.25 and purchases the same proportion of new assets with a beta of
1.1. What will be the firm's new overall WACC, and what rate of return must the new
assets produce in order to leave the stock price unchanged?
15.645%, 14.7%
Calculations:
Original Return on Equity = 7 + 1.25(7)
= 15.75%
When Beta = 1.1
Return on Equity = 7 + 1.1(7)
= 14.7%
The firm’s new overall WACC = 0.1(14.7) + 0.9(15.75)
= 15.645%
The rate of return the new assets must produce in order to leave the stock price
unchanged = 14.7%