Question: The Aikman Companys target capital structure is the debt-to-equity ratio (D/E) of 2/3. The equity beta is 1.5. Assume a risk-free rate of 9% and

The Aikman Company’s target capital structure is the debt-to-equity ratio (D/E) of 2/3. The equity beta is 1.5. Assume a risk-free rate of 9% and a market risk premium of 6%. The cost of debt is 12%. Corporate tax rate is 40%. Aikman has the following independent projects, which have the same risk as that of the firm:

Project A: Initial cost=$5 million; IRR = 22%

Project B: Initial cost=$5 million; IRR = 14%

Project C: Initial cost=$5 million; IRR = l 1%

Required:

1) What is the weighted average cost of capital (WACC) of the company?

2) Can Aikman’s firm-wide WACC used to evaluate projects A, B and C? Which projects should Aikman accept? Why?

3) Aikman is considering another independent project D, and its beta is estimated to be 2.0. What would be the consequence if Aikman’ firm- wide WACC is used to evaluate the project D? Why?

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