Grand Enterprises is an all-equity firm with two divisions: office equipment and packaging. The office equipment division accounts for 35% of the firms market value and the packaging division accounts for 65% of the firms market value. The asset beta of firms in the office equipment industry is 1.9 and the asset beta of firms in the packaging industry is 0.7. The risk-free rate is 3% and the market risk premium is 9%. Assume that there are no corporate taxes.

a. (5 points) Estimate Grands equity cost of capital.

Grand is currently evaluating two investment opportunities: it has a project called A in the office equipment division and a project called B in the packaging division. Each project requires an investment of $50,000 today, which will be financed entirely with equity.

Project A is expected to generate a cash-flow of $7,500 in one year (t=1). The cash-flow is then expected to grow at 3% per year forever.

Project B is expected to generate a single cash-flow of $55,500 in one year (t=1).

b.(5 points) Is project A on, above or below the Security Market Line (SML)? Briefly motivate your answer.

c.(5 points) Is project B on, above or below the Security Market Line (SML)? Briefly motivate your answer.

d.(5 points) Should Grand invest in project A? Should Grand invest in project B? Briefly motivate your answer.