You have been asked to estimate the cost of capital for the chemical division (CD) of a large conglomerate. The conglomerate has a beta of 0.9, the debt/equity ratio of 40%, a debt rating of AA yielding 5% and a 40% marginal tax rate. Competitors, on average, in the chemical industry have a beta of 1.3, debt/equity ratio of 70%, and debt rating of BBB yielding 6.5%. CD focuses on research and outsources its manufacturing, while all the competitors are vertically integrated. The chemical industry has a fixed/variable cost structure of 60% while CD is able to operate at 35% due to its outsourced manufacturing strategy. The current yields on government issues are 3% for 30 year bond and 1.5% on the T-bill. What is the cost of capital ?Do we need to deleverage and releverage beta to find the cost of capital ?
Can you share the ans ? I would think you need to unlever the Beta using the cometitor’s cost structure and then lever to get the beta for cd , use that to finf cost of equity then use the AA rated debt yield to get the cost of debt then put these values into WACC calculation
Why do we have to unlever and re-lever back. Is this firm in a developing economy?
Please ignore, this question was already answered here: http://www.analystforum.com/phorums/read.php?13,951515,951515
see book 7 problem 
I have recommend finance08 for the Q2 banned list. JK!