5) The large, consistently profitable firm you work for is considering a small project. Your firm is financed by 60% equity and 40% debt.Its cost of equity is 10%.Its cost of debt is 5%.The risk free rate is 5%.Corporate taxes are 40%.The expected rate of return on the market is 11%.Assume CAPM is correct and the project is just as risky as your firm. 

BETA(unlevered firm) = (Equity / ((Equity) + (1 - tax rate)*(DEBT))) *BETA(levered firm)

The project will cost $1000 at time 0, and is expected to produce $1250 at time 1, and no other cashflows. The firm is considering $600 debt at 6% and $400 equity to finance it.

a) What is the cost of equity for the project?,

What is the WACC of the project?, What is the NPV using WACC?

b) What is the APV of the project, including the tax shield (show both calculations)?

c) Explain for what kinds of projects would it make most sense to use WACC vs. APV.

d) Why might it matter that the firm is large and consistently profitable?

Answer rating: 100% (QA)

a To calculate the cost of equity for the project we use the Capital Asset Pricing Model CAPM formula CostofEquity RiskFreeRate BetaMarketRiskPremium ... View the full answer