DEF Corporation considers whether it would invest project A or project B, and the cash flow

for each project is given in the above table. Assuming firms weighted average cost of capital

is equal to the weighted average cost of capital for any project. The stock of the company has

a volatility of 18% and an equity beta of 0.9. It is expected that the rate of return for the market

is 15%, and the risk free rate is at 3%. The company can issue 10-year coupon bond at the price

of $1100 per bond, in which the face value of a bond is $1000 with 5% coupon rate, and the

coupon would be paid annually. The expected bond rating is at AAA, and the probability of

default for the bond is assumed to be 0%. The corporate tax rate is at 20%.

a) Calculate the cost of equity based on Capital Asset Pricing Model (CAPM)

b) Calculate the yield to maturity for the coupon bond.

c) If the company invests project A and finance it with 40% of equity and 60% of debt,

(i) what is the weighted average cost of capital?

(ii) what is the change in value for the firm?

d) If the company invests project A and finance it with 50% of equity and 50% of debt, do

you expect the change in value for the firm in this case would be greater than, equal to, or

smaller than the one in part (c)? Explain it with not more than 80 words (calculation is Not

required).

e) Assume the required return rate for each project is 10%. Compute the internal rate of return

(IRR) for each project (project A and project B), and discuss which project(s) should be

invested if the project are independent.

f) Assume cash flow is evenly distributed within the same year.

(i) Calculate the payback period for each project.

(ii) Which project(s) should be invested if the project are mutually exclusive and the cut

off period is 2 years? Discuss it with not more than 60 words.

(iii)If the cut-off period is 3 years, would you have a different answer compared to the one

in part (ii)? Discuss it with not more than 60 words.

Project Year 0 Year 1 Year 4 Cash Flow Cash Flow Cash Flow ($million) -80 Year 2 Cash Flow ($million) 50 Year 3 Cash Flow ($million) 60 ($million) 40 ($million) N/A A B -76 30 30 30 30