ACTSC 372 – Assignment 2 – Solutions
1.
[8 points] P&P Inc. is a firm with an equity beta of 0.85. Its longterm debt currently has a yield
tomaturity of 5%. The current debttoequity ratio of the firm is 0.38 and the current corporate tax
rate is 35%. The market risk premium is 8% and the riskfree rate is 3%. The company is considering
a project that will generate annual aftertax cash flows of $210,000 at the end of each year for 4 years.
The project requires an immediate investment of $800,000. (a) If the project has the same risk as the
firm as a whole, should P& P undertake the project? (b) What is the smallest value for the annual
aftertax cashflow that would justify the project being undertaken?
Solution:
(a) The NPV is 210
,
000
a
4
e
r

800
,
000 where
r
=
r
wacc
=
B
B
+
S
r
B
(1

T
c
) +
S
S
+
B
r
S
,
where
r
S
=
r
f
+
β
(
μ
M

r
f
) = 0
.
098, so
r
wacc
=
0
.
38
1
.
38
×
0
.
05
×
0
.
65 +
1
1
.
38
×
0
.
098 = 0
.
07996
.
Hence the NPV is 104,397.27 so the project should not be undertaken.
(b) The smallest value is 800
,
000
/a
4
e
r
= 241
,
517
.
16.
2.
[8 points] Wheezie Inc. is considering undertaking a project that would generate aftertax cash flows
of $100,000 for two years, and then $200,000 for the three next years. All cash flows occur at the end
of the year. The firm has a debttoequity ratio of 0.6. The cost of equity is 14% and the beforetax
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 Spring '09
 MARYHARDY
 Firm, Wheezie Inc.

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