The Tristar Company (the Company) has $285 million of risk free debt outstanding at the same time its common stock is worth $665 million. Its firm’s equity beta is estimated to be 1.25. The Company cost of debt is 6%, the same as the risk free rate. The return on the market is 14%.

A. What is Tristar’s weighted average cost of capital (WACC)? Assume there are no taxes.

B. Now suppose that the Company pays corporate taxes at a 35% rate. Assume that the before tax cost of debt is still 6%, and that the cost of equity is now 14.95%. What is the Company’s WACC?

C. The Company has an investment project that will expand the size of its existing business. The project costs $275,000 and will generate an after tax cash flow of $34,905 per year forever. The Company intends on keeping its debt ratio constant. What is the NPV of this project?

D. Now suppose the Company is evaluating two independent investment projects. Project A is a new process to manufacture a wireless phone. Suppose project A requires an investment of $1000 and produces $600 per year for two years. Project B involves an innovative optical carrying approach to wireless communications. This project also requires an investment of $1000 but is estimated to generate $620 per year for two years. The risk free rate is still 6% and the market risk premium is 8.5%.

Calculate the NPVs of these two projects and make your recommendation on whether they should be accepted or rejected based on the following project and firm information:

Project Beta

A 0.8

B 1.2

Firm 1.0

Answer rating: 100% (QA)

A To calculate the weighted average cost of capital WACC we first need to calculate the cost of debt and the cost of equity The cost of debt is given ... View the full answer