Question

Section: Name: Q5. Project Cost of Capital (25 points) SAIPA Corp. is a publicly traded company that specializes in car manufacturing. The company's debt-to-equity ratio is 1/4 and it plans to maintain the same debt-to-equity ratio indefinitely. SAIPA's cost of debt is 7%, and its equity beta is 1.5. Risk free rate is 5%, market risk premium is also 5 % , and corporate tax rate is 40% Suppose that SAIPA is contemplating whether to starta new car production line. This project will be financed with 20% debt and 80% equity. The cost of debt for the new project is the same as current SAIPA's cost of debts. What discount rate should SAIPA use to discount the cash flows from its new car production project? a. (7 points)

please show step by step and where you got the info

please no excel

Answer 1

Page No Q5 b. Company Beta Yamaha DE Slonda 2 1.25 lets unlever both the beta Yamaha ilsset bete = Equity beta x 1 1 + (1-ENTE beta = 18 × 1 - ! +-40196 1] Asset - 1.8 * 1 1+ 0.6 Asset beta Yamatos 1.125 1- 0.4 Honda deset leta = Equity beta x ! 1 + ((( t) DLE) Asset beta = x 1 1 +() X1:25] S 2X1 [ + (0-6 (1-25)] = 2 x 1 1+ 0.75 143 Honda Asset beta

50:50 Now lets relever it using projer debt equity rate which is so Equity beta Yousake = esset bele x 1 + (1-1) - 1.125xLI+(-0.4)0:57 1.125 x L 1 +0:3] Equity hele Yamaha = 1.4.625 Equity bello Honda - Asset beta x 1 + (1-7) - 1.143 XLi +(0.6)0.6] = 1.143 x [1 +0:33 Equity bela ronda = 1.4899 Industry beta = Average Yamahe, stonde - 1.4625 + 1.4859 Industry bela = 1.4742 WACC = wko wke Kd = 6% lot) 6:1. (-40%) 3.6% Kd = Ke = Rt + BCMR - Rf) = 5.1 + 1.4742 (56) = 5% + 7.371%. - 12:37).

Date: Page No: WACC = 0.51 3.64.) a 1.8% + WACC = 7.9856% + 0.5 12.3712) 6.1855% Therefore , SAIPA should use WACC of 7.9855% to discount cash flows of speed boat manufacturing luisiness.

Dorte ) Page No: - a) Cost of debt = 71. B = 1.5 Rf = 5.1. Mpp = 51 t = 40.1 D/E = 1 WACC = WAKd & woke Kd = Cost of debt (1 t) Kd = 71.11 401) Kd = 4.2% us CAPM] As per ke = Rf + B (MR - Rf) Ke - 5% + 1.5 (64) Ke = 12.5% WACC = 0.2 (4.24.) +0.8 (12.5.1) = 0.84.1. + 10.7. WACC = 10.84% Therefore, the discount rate be use by SAIPA to cash flows from its new plant will be 10.841. which will ut the discount the car produ
Common notations for my answer:

WACC = weighted average cost of capital (discounting factor of project)

D/E = Debt to equity ratio

t = tax rate

Kd = Cost of debt

Ke = Cost of equity

Rf = Risk free rate

Mr = Market return

(Mr-Rf) = Risk Premium

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For part a: We have all the data needed to find WACC available in question, therefore using CAPM for Ke and Kd after adjusting tax, we can easily find WACC for the new car production line as shown in pictures above

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For part b: For speed boat manufacturing project's discounting factor, we will first need to find industry beta. The two company's beta is given which we will first unlever it using their own debt equity ratio and then relever it using our projects debt equity ratio (50-50). Then we will take average to get industry beta. I have not used cost of debt formula for finding beta because using this approach makes our task easy and fast.

Let me know if you want additional explanation!

Thank You