Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The company is currently 30% debt financed. The companys analysts have estimated the projects cash flows but need to determine the project cost of capital. Canada Telecom analysts assess that their new multimedia division has a target debt-equity ratio of 0.6, and a cost of debt of 6.5%. In addition, the risk-free rate is 3%, and market risk premium is 5%.

XYZ Co. is a pure play in the multimedia business and is 35% debt financed. Its current equity beta is 1.05. Assume that both Canada Telecom and XYZ have a tax rate of 35%, and a debt beta of 0.

1. Is Canada Telecoms WACC the right discount rate for its new project? Why or why not? (5 marks)
2. Explain why you cannot use XYZs equity beta (1.05) as a proxy for the equity beta of Canada Telecoms new project. Estimate the new projects equity beta. (10 marks)
3. What is the new projects cost of capital? (5 marks)