A company has a market capitalisation of $80 million and outstanding debt of $20 million. Beta for the company is 1.5, the debt cost of capital is 10% per annum and the tax rate is 30%.

a)Calculate the Equity Cost of Capital using the Capital Asset Pricing Model (CAPM) given the risk free rate is 2% per annum and the market premium is 5%.

b)Calculate the Weighted Average Cost of Capital (WACC) for the company. 

The company is considering two alternate projects:

A: Requires an investment of $100,000 now. In return, the company expects to receive six annual payments of $25,000 with the first payment at the end of the year of investment. 

B: Requires an investment of $100,000 now and a further investment of $10,000 one year from now. In return, the company will receive $90,000 four years from now and another $90,000 seven years from now. 

c) Write down an expression for the net present value of Project A. Clearly define your parameters. 

d)  Using a 'hurdle rate' of 10% per annum as the effective annual interest rate, calculate the net present value of Project A.

e) Using a 'hurdle rate' of 11% per annum as the effective annual interest rate, calculate the net present value of Project B. 

f) By comparing the net present value of each project recommend, with reasons, which project the company should undertake.

Answer rating: 100% (QA)

a Equity Cost of Capital using CAPM The formula for the cost of equity using the Capital Asset Pricing Model CAPM is Cost of Equity RiskFree Rate Beta x Market Risk Premium Substituting the given valu... View the full answer