Question: A firm has the following capital structure based on market
A firm has the following capital structure based on market values: equity 65 percent and debt 35 percent. The current yield on government T-bills is 2 percent, the expected return on the market portfolio is 10 percent, and the firm’s beta is approximated at 2.1. The firm’s common shares are trading at $25, and the current dividend level of $3 per share is expected to grow at an annual rate of 4 percent. The firm can issue debt at a 3 percent premium over the current risk-free rate. The firm’s tax rate is 40 percent, and the firm is considering a project to be funded out of internally generated funds that will not alter the firm’s overall risk. This project requires an initial investment of $12 million and promises to generate net annual after-tax cash flows of $2 million perpetually. Should this project be undertaken?
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