ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100, 6% coupon rate, and 10 years to maturity. The common stock has a standard deviation of return of 30% and a correlation coefficient with S&P 500 return of 0.75. The S&P500 has a return of 12.5% and a standard deviation of return of 20%. The T-bill rate is 3.5%. The debt has a default risk premium of 2% and a maturity risk premium of 1%. The stockholders are expected to receive a dividend of $2 five years hence and a stock price of $105 five years hence. ABC Inc. has a corporate tax rate of 30%.

1. Determine the cost of common stock, and the cost of debt.

2. What is the capital structure of ABC? (How much of the capital is raised by issuing common stock and debt, respectively?)

3. Determine the weighted average cost of capital.

4. If ABC has an investment that requires an outlay of $100 million, and generates cash flow of $60 million in one year, $40 million in two years and $15 million in three years. Use both net present value and internal rate of return criteria to determine if the investment is acceptable.