A project being considered has a similar risk level as the firm itself. The firm's equity beta is 2.0, the market returns are 12.8 and the return on 30 day treasuries is 4%. The YTM on the firm's bonds is 13%. The firm does not have any preferred stock.

a. What is the firms cost of equity?

b. (You look at the balance sheet and see that there is $750 million of equity and $250 million of debt. The firms tax rate is 30%. What cost of capital should you use to analyze this project using the NPV method?

c. (You are now calculating the cost of capital to use when evaluating a second project which has a very different risk level than that of the firm itself. The project will be funded with 90% equity capital and 10% debt. You look up public firms which are comparable in risk to the proposed project and the average equity beta for these comparable firms is 3.1. If you assume the debt beta is 0, what cost of capital should you use to evaluate this project?

Answer rating: 100% (QA)

a The firms cost of equity can be calculated using the Capital Asset Pricing Model CAPM Cost of Equi... View the full answer