"You are a business consultant specializing on the cost of capital and the estimation of discount rates capital projects. You start your day with updating your market inputs you will need in estimating the cost of capital estimates for two of your clients capital projects you are currently working on. First, you find out that long-term government bonds are currently yielding at 4.5%. Nest, based on perusing some financial analyst reports mainly concerned with the outlook for the Australian stock market in the coming year, you decide that an expected market return of 15% is appropriate. Having established these fundamental estimates, which you will require for both assignments, you begin with reviewing the data for your first client.
b. Satori Ltd is your second client. One of Satoris senior managers, Mark Powell, has proposed to enter into a new line of business. Marks project analysis yielded an estimated IRR of 26%. In his report, Mark compared the projects IRR to Satoris WACC of 12.5% and concluded that the project should be accepted. Given that Mark has a history of overestimating cash flow projections and underestimating the involved risk, the CEO is skeptical and asked you for your comments on Marks proposal. Your background research shows that the average beta coefficient for listed companies operating in the proposed business line is 2.0, confirming the high-risk nature of the project. Like Satori, these companies are all equity financed.
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