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Unformatted text preview: 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 = . 38 1 . 38 × . 05 × . 65 + 1 1 . 38 × . 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 endof $100,000 for two years, and then $200,000 for the three next years....
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This note was uploaded on 11/16/2011 for the course ACTSC 372 taught by Professor Maryhardy during the Spring '09 term at Waterloo.
 Spring '09
 MARYHARDY

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