Question

Part A
The common stock of Conservation & Construction, Inc. (CCI) has a beta of .8. The Treasury bill rate is 4% and the market risk premium is estimated at 7%. CCI’s capital structure is 30% debt paying a 5% interest rate, and 70% equity.
Required: What is CCI’s cost of equity capital and WACC? Assume CCl’s tax rate is 35%.
Part B
CCI is evaluating a project with an internal rate of return of 12%.
Required: Based on the data given and your computations in part A, should CCI accept the project? If the project will generate a cash flow of $100,000 per year for 7 years, what is the most CCI should be willing to pay to initiate the project?

Answer 1

Cost of equity

$r_{e} = r_{f} + \beta *(r_{m} - r_{f})$

$r_{e} = 0.04 + 0.8 *0.07$

$r_{e} =0.096 = 9.6\%$

$WACC = w_{d}*r_{d}*(1-t) + w_{e}*r_{e}$

$WACC = 0.3*0.05*(1-0.35) + 0.7*0.096$

$WACC = 0.07695 = 7.695\%$

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