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1. Catola Shoes, an athletic shoe and clothing manufacturer, is considering a move into the fashion clothing business, making high-priced casual clothing for the teenage and young adult markets. The beta for Catala is 0.90, calculated using monthly returns over the last 5 years and against the S&P 500 Index. You have estimated the unlevered beta for fashion apparel companies to be 1.15. The current stock price for the firm is $55 and there are 700 million shares outstanding. Catola expects to finance this apparel division using the same mix of debt and equity(in market value terms) as it is using currently in the rest of its business. Catola has debt outstanding with a book value of $2 billion and an average time to maturity of 5 years. The company's interest expense last year was $150 million. Catola's debt is currently rated A+, and A+ rated bonds trade at a default spread of 1.0% over the long-term treasury bond rate. The 10-year U.S. Treasury bond currently yields 3% and the market risk premium is 6%.Catola pays a marginal tax rate of 40%.
What cost of capital should Catola use in evaluating this project?
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