Misui [4]

Misui, Inc is a levered firm with a debt-to-equity ratio of 0.25. The beta of common stock is 1.15, while that of debt is 0.3. The market premium (expected return in excess of the risk free rate) is 10% and the risk free rate is 6%. The CAPM holds.

1. If a new project has the same risk as the common stock of the firm, what discount rate should the firm use?

2. If a new project has the same risk as the entire firm (debt and equity), what discount rate should the firm use? (Hint: Betas are "additive." In the present context, this means the following. The value of the firm (V) equals the sum of the value of equity (E) and debt (B). That is, the firm is really a portfolio of equity and debt. As a result, the beta of the firm equals the weighted average of the betas of equity and debt, where the weights are given by the ratios of E over V and B over V, respectively.)