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ABC Corporation, which specializes in the furniture business, is considering an expansion. ABC maintains a constant debt-to-value ratio of 40%. The firm's equity beta is 0:75 and its debt beta is zero. The expansion costs $1m today and generates unlevered after-tax cash flows of $300; 000 per year in perpetuity. The risk of the expansion project is the same as that of the firm's existing business. Also, ABC intends to continue with the same debt-to-value ratio after the expansion. The risk-free rate is 5%, the market risk premium is 10%, and the corporate tax rate is 25%.
1) Can we use ABC's rWACC to value the project? If so, why? If no, why not? Explain
2) Should ABC undertake the expansion?
3) How much debt would ABC need to raise in order to finance the expansion?
4) Suppose shareholder's wealth without the expansion project equals E. What is shareholder's wealth in case ABC were to undertake the project?
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