2. The common stock of TWO, Inc. has a beta of 0.90. The short term U.S. Treasury bill rate is 4% and the market risk premium is estimated at 8%. TWO, Inc. is financed with 30% debt and 70% equity and pays 40% in taxes. Assume the debt is risk free.

(a) What is TWO, Inc.s weighted average cost of capital asssuming that interest paymnets on debt are tax-deductible and the firm is profitable. [8 points]

(b) You are provided with the following forecasts (in millions of dollars) of TWO, Inc.s profits and of its future investment in new property, plant and equitment (i.e., CAPEX). After year 4, EBITDA, depreciation, EBIT, and investment are expected to grow at a constant rate of 5% from their respective year 4 levels indefinitely. The company also plans on maintaining a capital structure of 30% debt and 70% equity indefintiely. Based on this information and your answer to part a, estimate TWO, Inc.s total value and the separate values of equity and debt [HINT: You need to find the total free cash flows]

Table 1: TWO, Inc. Year 1 Year 2 Year 3 Year 4 EBITDA 80 100 115 120 Depreciation 20 30 35 40 Pretax Profit (EBIT) 60 70 80 80 Net Investment (CAPEX) 12 15 18 20