Q13.24. Practice the CAPM. A $300 million firm has a

beta of 2. The risk-free rate is 4%; the equity premium is

3%. Assume that the firm can easily tap a perfect capital

market to obtain another $95 million. The firm can also

easily tap the financial markets. So far, it has had a policy

of only accepting projects with an IRR above the hurdle

rate of 10%. Suddenly, one of its main suppliers (perhaps

one facing credit constraints) has approached the firm for a

1-year loan. Assume that the loan is risk-free for you--you

hold more than enough sway over your supplier to ensure

repayment. The supplier wants to borrow $100 million and

pay back $106 million next year.

Without the new loan, what is the firm expected to

earn per year?

2. What is the NPV of the loan?

3. If the firm changes its policy and extends the loan,

how would its value change?

4. If the firm changes its policy and extends the loan,

approximately how would its beta change?

5. If the firm changes its policy and extends the loan,

approximately how would its cost of capital change?

6. If the firm changes its policy and extends the loan,

can you compute the combined firm's NPV by divid-

ing its expected cash flows (assets) by its combined

cost of capital?

7. Should the firm change its policy?