Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The company is currently 30% debt financed. The company's analysts have estimated the project's cash flows but need to determine the project cost of capital. Canada Telecom analysts assess that their new multimedia division has a target debt-equity ratio of 0.6, and a cost of debt of 6.5%. In addition, the risk-free rate is 3%, and market risk premium is 5%.

XYZ Co. is a pure play in the multimedia business and is 35% debt financed. Its current equity beta is 1.05. Assume that both Canada Telecom and XYZ have a tax rate of 35%, and a debt beta of 0.

(1)Is Canada Telecom's WACC the right discount rate for its new project? Why or why not?

(2)Explain why you cannot use XYZ's equity beta (1.05) as a proxy for the equity beta of Canada Telecom's new project. Estimate the new project's equity beta.

(3)What is the new project's cost of capital?