Phils is a sit-down restaurant that specializes in home-cooked meals. Theresas is a walk- in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped doughnuts, sandwiches, and wraps at a local beach. Phils currently has a WACC of 14% while Theresas WACC is 10%.

The expansion project has a projected net present value of 12,600 at a 10% discount rate and a net present value of -2,080 at a 14% discount rate.

(a) Which firm or firms should expand and offer food at the local beach during the summer months? Discuss your point of view.

(b) Phils is a subsidiary of Greggs. The parent company - Greggs maintains a debt-equity ratio of 0.65 and has a tax rate of 32%. The pre-tax cost of debt is 9.8%. There are 25,000 shares of equity outstanding with a beta of 1.2 and a market price of 19 a share. The market has a 12.1% rate of return, and the current risk-free rate is 3.6%. This year, the firm paid an annual dividend of 1.10 a share and expects to increase that amount by 2% each year. Using an average expected cost of equity, what is Greggs weighted average cost of capital?

(c) Theresas belongs to Harvester, which has expected earnings before interest and tax (EBIT) of 45,000 in perpetuity and a tax rate of 30%. Harvester has 60,000 in outstanding debt at an interest rate of 8%. The unlevered cost of capital is 12%.

1. What is the value of Harvester according to MM Proposition I with taxes?

2. Should Harvester change its debt-equity ratio if the goal is to maximize the value of the firm? Explain.