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1. Consider a project to explore natural gas liquids. It requires a $10 million investment and offers a

level after-tax cash flow of $1.75 million per year for 10 years. The market risk of this project is

similar to the market risk of the projects taken by Apache Corp. Assume that the debt rate of

Apache is 4.6% and the beta of debt is zero. Also, the debt level is kept the same forever. The

marginal tax rate of Apache is 35%. Ignore Bankruptcy costs.

a. Suppose the project is 100% equity finance, what is the cost of capital of the project?

What is the NPV of the project? Would you invest in the project?

b. Suppose the project is financed with $5 million of debt and $5 million of equity. The

interest rate is 7%. The marginal tax rate of the corporation doing the project is 35%. The

debt will be paid off in annual installments over the project's 10-year life. Calculate

APV.

*note : Assume that the market risk premium is equal to 7%. For the risk free rate you can use the yield on a 10Y T-NOTE. Currently, it's value is at 2.32%. For the regression, you can use 3 years of monthly returns.