Q 12.7. Some companies believe they can use the blended post-acquisition cost of capital as the appropriate

Question:

Q 12.7. Some companies believe they can use the blended post-acquisition cost of capital as the appropriate discount rate. However, this also leads to incorrect decisions. Let's explore this in the context of the example in the text: The risk-free rate is 3%, the equity premium is 4%, and the old firm is worth $100 and has a market beta of 0.5. The new project costs $10, is expected to pay off $11 next year, and has a beta of 3. 1. What is the value of the new project, discounted at its true cost of capital, 15%? 2. What is the weight of the new project in the firm? (Assume that the combined firm value is around $109.48.) 3. What is the beta of the overall (combined) firm? 4. Use this beta to compute the combined cost of capital. 5. Will the firm take this project? (Use an IRR analysis.) 6. If the firm takes the project, what will the firm's value be?

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question
Question Posted: