(a) DSH Limited. is analyzing a proposed project. The company expects to sell 12,000 units, plus or minus 4 percent. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The fixed and variable cost estimates are considered accurate within a plus or minus 6 percent range. The depreciation expense is $30,000 per year, over the 5-year life of the project, using the straight line. The tax rate is 35 percent. The sale price is estimated at $14 a unit, plus or minus 5 percent.

(i)What are the earnings before interest and taxes under the base case (i.e. expected) scenario?

(ii) What are the earnings before interest and taxes under a best-case scenario?

(ii)What is the net income under the worst-case scenario?

(iv)What is the NPV under the base case scenario if the required rate of return is 12%?

(b) DSH Ltd. has a debt-equity ratio of 1. Its weighted average cost of capital is 11%, and its cost of debt is 9%. The corporate tax is 35%.

(i)What is DSH's cost of equity?

(ii)What is KLD's unlevered cost of equity?

DSH is increasing the proportion of debt in the firm (at the same cost) so that the new debt-equity ratio is 1.5.

(iii)What is the new cost of equity?

(iv)What is the weighted average cost of capital?

(v)Explain why the cost of equity changes when the debt-equity ratio changes.