1. Capital Structure, WACC, and Firm Investment

Suppose a firm can borrow money to finance projects from a bank at a marginal, pre- tax rate of 4.0%. Suppose the firms stock currently has a beta of 1.2, the market risk premium is 6% and the risk-free rate is 4.0%. The firm is currently financed with 40% debt and faces a 30% marginal tax rate. The firm is considering an average-risk project with the following free cash flows:

Year	0	1	2	3	4
FCF	-216,000	100,000	75,000	50,000	25,000

1. Compute the firms WACC.
2. Compute the projects NPV and IRR.
3. Should the firm invest in the project? Why or why not?

Now, assume that the CFO has determined that, when financing the project, the firm will also recapitalize so that the firm would be financed with 50% debt.

4. Compute the firms unlevered beta.
5. Compute the firms WACC after re-capitalizing.
6. Re-calculate the projects NPV.
7. Has the firm changed its view of whether to accept the project? Explain why or why not.