A project requires an initial investment in equipment of $760,000 immediately (t=0) and is expected to produce sales revenue of $697, 000 the first year; this revenue will increase by 4.5% per year over the next four years. Manufacturing costs are estimated to be 67% of the sales. The project demand analysis, which was done last year, cost $235,000. The asset can be depreciated on a straight-line basis over five years to a zero salvage value. The corporate tax rate is 36%. The project requires an investment in working capital. Specifically, at the beginning of the project (t=0), $45,000 of working capital is required; thereafter, working capital is projected to be 6.0% of revenue. The investment in working capital will be recovered at the end of the fifth year. At the end of the 5th year, the company plans to sell the equipment for $18,900.

To calculate the cost of capital for this project, the firm is going to use the following companies as comparable firms.

	Beta	Debt	Equity
XOM	1.00	11.63B	403.10B
CVX	1.22	20.02B	224.24B

Assume that the market risk premium is 6%, the risk free-rate is 5%, and all debt is risk free, static and perpetual, and that the CAPM holds. The firm is going to finance the project with all equity.

1. Determine the cost of capital for this project.

2. Given the project described above, should the investment be undertaken?

Answer rating: 100% (QA)

a cost of capital cost of equity as the firm is going to finance the project with all equity cost of ... View the full answer