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The total book value of the firm's equity is c20 million, and book value per share is €40
The total book value of the firm's equity is c20 million, and book value per share is €40. The stock has a market-to-book ratio of 2.0. The firm's bonds have a face value of €10 million and sell at a price of 98% of face value. The yield to maturity on the bonds is 8%. The common stock has a beta of 1.15. The Treasury bill rate is 3%, and the market return is estimated at 10% The firm's tax rate is 35% Instructions: 1. Find the firm's WACC (15 points) 2. The firm is considering two Independent projects with an average level of risk. Internal rate of return of Project 1 15 8%. Internal rate of return of Project 2 is 9% Advise the company whether it should accept or reject these projects. (5 points)
Expert Solution
Market value of equity =Market To Book Value*Book Value of equity =2*20 =40
Cost of Equity =risk Free Rate + Beta*Market risk Premium =3%+1.15*(10%-3%) =11.05%
Market Value of Bond =98%*Face Value of Bond =98%*100 =98
Before Tax Cost of Debt =YTM =8%
1. WACC =Weight of equity*Cost of Equity + Weight of Debt*Cost of Debt*(1-Tax Rate)
=40/(40+98)*11.05%+98/(40+98)*8%*(1-35%) =6.8957%
2. An independent project should be accepted if IRR is greater than WACC.
Both Project 1 and project 2 should be selected since IRR of both is greater than WACC
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