Forton plc. is considering opening a restaurant in Lancaster. The project requires an initial investment of £400,000 in building activities. For this project, Forton is planning to use a piece of land purchased 5 years ago at £350,000. The current value of the land is £300,000 and £20,000 is required to be invested for landscaping activities before building commences. Cash flows from sales and cash costs all occur at a frequency of 12 months indefinitely. The first sales and cost cash flows occur one year after the implementation of the project and the variable cost of the project amounts to 40% of sales. The firm is subject to 20% tax rate and the firm's all-equity cost of capital is 10% per annum. The firm's cost of debt is 6% per annum and, for simplicity, it can be assumed that the corporate debt of this firm is risk-free. The initial cash outflow of the project does not trigger any depreciation. Assume that this is the only project of the firm. If the project is financed with 100% equity its net present value is -£48,000 (negative).

 i) What is the level of sales that the project generates each year? (6 marks)

 ii) Assume that 50% of the initial cash outflow is financed with debt. Calculate the adjustedpresent-value. Should the firm implement the project under the new assumption? (5 marks)

iii) Assume that, as in (ii), 50% of the initial cash outflow is financed with debt. Use the flow-toequity approach to calculate the net present value of the project. Should the firm implement the project?

 iv) Assume that, as in (ii) and (iii), 50% of the initial cash outflow is financed with debt. Use the weighted-average-cost-of-capital approach to calculate the net present value of the project. Should the firm implement the project? (6 marks)

v) What is the level of debt and equity that makes the firm indifferent between accepting and rejecting the project? (4 marks)

 
b) What factors determine the beta of the equity? How do you calculate beta in practice and what are the pitfalls you may face in this calculation? (12 marks)

c) Beta plc. has decided to borrow money by issuing callable bonds with annual coupon payments. The bonds are perpetual, have a face value of £1,000 and are callable at £1,250. One-year interest rates are 6%. There is 60% probability that long-term interest rates one year form today will be 9%, and 40% probability that long-term interest rates will be 4%. Assume that if interest rates fall the bonds will be called (at year 1). What coupon rate should the bonds have in order to sell at par value?