3. 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).

2. (5 points) Is project A on, above or below the Security Market Line (SML)? Briefly motivate your answer.

3. (5 points) Is project B on, above or below the Security Market Line (SML)? Briefly motivate your answer.

4. (5 points) Should Grand invest in project A? Should Grand invest in project B? Briefly motivate your answer.