Problem 4 (25 points) Trader Joe's is considering opening a new grocery store in Berkeley. Doing so will require an upfront investment of $12M. The (after-tax) free cash flows from opening the new store are expected to be $1.5M at t = 1 and are expected to grow at a rate of 3% in perpetuity. Trader Joe's is a private company so in order to estimate the riskiness of the project, it uses information about its two closest competitors: Safeway and Whole Foods. Safeway Whole Foods Equity Value ($B) 10 Debt Value ($B) 20 Equity Beta 2.5 1.9 Debt Beta 0.6 0.2 The current tax rate is 35%. The current riskless rate is 3% and the market risk premium is 5%. (a) Using the two comparables above, estimate the asset beta for the project. (b) Suppose that Trader Joe's finances the project with 100% equity. (i) Estimate the (unlevered) cost of capital for the project. (ii) What is the NPV of the project? (iii) What is the IRR of the project? (c) Suppose instead that Trader Joe's decides to finance the investment using a debt/ value ratio of 0.4 and that its debt will have a beta of 0.5 (Bp = 0.5) (i) What is the weighted average cost of capital (WACC) for the project? (ii) What is the NPV of the project? (iii) How much should Trader Joe's borrow at t = 0 in order to achieve its desired debt/ value ratio