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Unformatted text preview: he project has the same risk as the average project of the firm. Given an initial investment of $125 million, which is financed with 20% debt, what is the value of the project? The first insight is that although the business risk is identical, the project is financed with lower financial leverage. Thus, the WACC cannot be used as the discount rate for the project. Rather, the WACC should be adjusted using the three step procedure. Step 1: Estimate opportunity cost of capital, i.e. estimate r using a 40% debt ratio, 60% equity ration as well as the firm's cost of debt and equity o - WACC NPV 125  11.83 0.0986 -$5.02 million In comparison the NPV is equal to $5.03 if the company WACC is used as the discount rate. In this case we would have invested in a negative NPV project if we ignored that the project was financed with a different mix of debt and equity. Download free ebooks at 68 Corporate Finance Corporate financing and valuation 8.11 Dividend policy Dividend policy refers to the firm's decision whether to plough back earnings as retained earnings or payout earnings to shareholders. Moreo...
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.

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