Fine Winehouse is analyzing an investment very different from its current investments. The initial investment would be $500,000 with current liabilities increasing by $30,000. The anticipated revenues have been estimated at $150,000 a year for the six years of the project's life. At end of six years any remaining equipment would be salvaged for $55,000. Fine Winehouse has a tax rate of 28 percent, and the appropriate CCA rate for this capital project is 30 percent. Currently, the firm has 50 percent debt and 50 percent equity in its capital structure based on market values. It plans to maintain this capital structure in the foreseeable future. The existing shareholders expect a return of 15 percent on their investment, and new debt would require an 8 percent yield. The market risk premium is 7 percent, and the risk-free rate is 2.9 percent. The betas of firms in the wine house business with capital structures similar to Fine Winehouse's have revealed an average industry beta of 1.3.
a. Calculate the two possible discount rates to analyze the Winehouse investment.
b. Justify the choice of one of the discount rates.
c. Should Fine Winehouse proceed with the investment? Show your analysis.