Goodtread Rubber Company has two divisions: the tire division which manufactures tires for new autos and the
recap division which manufactures recapping materials that are sold to independent tire recapping shops throughout the United States. Since auto manufacturing
fluctuates with the general economy the tire division%u2019s earnings contribution to Goodtread%u2019s stockprice is highly correlated with returns on most
other stocks. If the tire division were operated as a separate company its beta coefficient would be about 1.50. The sales and profits of the recap division
on the other hand tend to be countercyclical because recap sales boom when people cannot afford to buy new tires. The recap division%u2019s beta is estimated
to be 0.5. Approximately 75 percent of Goodtread%u2019s corporate assets are invested in the tire division and 25 percent are invested in the recap division.
Currently the rate of interest on Treasury securities is 9 percent and the expected rate of return on an average share of stock is 13 percent. Goodtread uses
only common equity capital so it has no debt outstanding.
a. What is the new corporate beta?
b. What is the required rate of return on Goodtread%u2019s stock?
c. What is the cost of capital for projects in each division?