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Compute smart expected rate of return

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Reference no: EM132616657

SMART Telecom is considering a project for the coming year that will cost $50 million. SMART plans to use the following combination of debt and equity to finance the investment:

  1. Issue $15 million of 20-year bonds at a price of $101, with a coupon rate of 8%, and flotation costs of 2% of par.
  2. Use $35 million of funds generated from earnings.
  3. The equity market is expected to earn 12%. Government Treasury bonds are currently yielding 5%. The beta coefficient for SMART is estimated to be 0.60. SMART is subject to an effective corporate income tax rate of 40%.

Problem 1: The capital asset pricing model (CAPM) computes the expected return on a security, by adding the risk-free rate of return, to the incremental yield of the expected market return, which is adjusted by the company's beta. Compute SMART's expected rate of return.

Option 1) 7.20%

Option 2) 9.20%

Option 3) 12.20%

Option 4) 12.00%

Reference no: EM132616657

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