Question
ARE Corp is about to begin a new project and it is trying to decide how to raise the $8 million in capital that it
ARE Corp is about to begin a new project and it is trying to decide how to raise the $8
million in capital that it needs to finance the project. The project is expected to generate $1 million in EBIT
every year in perpetuity. These future earnings should be discounted at 10%. (Before taking on the
project, ARE Corp is an unlevered company with a total market valuation of $10 million and an
expected return of 10% on its equity.) There are no taxes, issuance costs, bankruptcy costs or agency costs of financing.
- Is ARE Corp making the right decision by choosing to start the project?
- ARE Corp is choosing between debt and equity financing. How should it finance the project? Justify your answer.
For parts (3)-(5), suppose that ARE Corp finances the project by issuing new equity.
3.
What is ARE Corp's value after it takes on the project?
4.
What is ARE Corp's WACC after taking on the project?
5.
Suppose you are an investor who owns a 5% stake in ARE Corp before the project. Suppose you buy 5% of the new equity. What is the expected return on your portfolio of investments in ARE Corp?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started