Question
Maxy Corp. considers a project in a new line of business which has no debt and an equity cost of capital of 14%. Suppose that
Maxy Corp. considers a project in a new line of business which has no debt and an equity cost of capital of 14%. Suppose that the firm decides to increase the project's leverage and to maintain the project's market debt-to-value ratio of 1/2. The project's debt cost of capital is 8% and its marginal tax rate is 21%. Assume that the project's unlevered cost of capital remains constant, i.e. 14%.
i. What will the project's effective after-tax WACC be with the addition of leverage? [2 marks]
ii. What does the value of the project increase by for every $1 in new permanent debt that the firm issues to finance the project? Explain
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