Question: Aerotyne International is an all-equity company invested in a single project with an expected after-tax cash flow of 1 million euros one year from now.

Aerotyne International is an all-equity company invested in a single project with an expected after-tax cash flow of 1 million euros one year from now. This cash flow is then expected to grow at 1% per year forever. The project has a beta of 0.8, the risk-free rate of return is 2% and the expected market return is 6%.

Aerotyne International is thinking about permanently increasing its leverage (debt over assets) to 20%. At that level of leverage, Aerotynes's cost of debt is 2%. Assume that the corporate tax rate is 25%.

How would this debt issue affect the firm's cost of equity and would it affect the firm's weighted average cost of capital (WACC)?

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