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Firm XYZ has 10 million outstanding shares, each selling for $15 per share. The firm's debt is publicly trading at 90 percent of its $75 million face value. The firm pays a 3.0% rate of interest (before-tax) on its new debt and has an equity beta of 0.90. The corporate tax rate is 35%. Assume that the market risk premium is 5.0% (note: the market risk premium is not the same as the market return) and that the current Treasury rate is 0.25%.
a. Compute WACC
b. Consider project A: the project costs $10 million and will generate after-tax (year-end) cash flows of $2.5 million per year for 4 years. The project has the same risk as the overall firm. Should the project be accepted?
c. Consider now project B: the project costs $2 million and will generate after-tax (year-end) cash flows of $1.1 million per year for 3 years. Note that this project presents no risks. Should the project be accepted?
d. Consider finally project C: the project costs $30 million and will generate after-tax (year-end) cash flows of $5 million per year for 5 years. The project is more risky than the overall firm, and hence has a beta of 2.0. Should the project be accepted?
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