Question 1 Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications The company is currently 30 debt financed The companys analysts have estimated the projects cash flows but need to determine the project cost of capital Canada Telecom analysts assess that their new multimedia division has a target debt equity ratio of 0 6, and a cost of debt of 6 5 In addition, the risk free rate is 3 , and market risk premium is 5 XYZ Co is a pure play in the multimedia business and is 35 debt financed Its current equity beta is 1 05 Assume that both Canada Telecom and XYZ have a tax rate of 35 , and a debt beta of 0 Is Canada Telecoms WACC the right discount rate for its new project Why or why not (5 marks) Explain why you cannot use XYZs equity beta (1 05) as a proxy for the equity beta of Canada Telecoms new project Estimate the new projects equity beta (10 marks) What is the new projects cost of capital (5 marks) Question 2 In March 2020, Snow Fun, Inc , made a rights issue at a subscription price of $10 a share One new share can be purchased for every 3 shares held Before the issue, there were 12 million shares outstanding, and the share price was $15 (1) What is the total amount of new money raised (2 marks) (2) What is the expected stock price after the rights are issued Why is the stock price expected to fall after the right issue (10 marks) (3) Suppose that the company had decided to issue the new stock at $8 instead of $10 a share, how many new shares would it have needed to raise the same sum of money Show that Snow Funs shareholders are just as well off if it issues the shares at $8 a share rather than $10 (8 marks)

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Question 1 Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The company is currently 30% debt financed. The companys

Question 1

Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The company is currently 30% debt financed. The companys analysts have estimated the projects cash flows but need to determine the project cost of capital. Canada Telecom analysts assess that their new multimedia division has a target debt-equity ratio of 0.6, and a cost of debt of 6.5%. In addition, the risk-free rate is 3%, and market risk premium is 5%.

XYZ Co. is a pure play in the multimedia business and is 35% debt financed. Its current equity beta is 1.05. Assume that both Canada Telecom and XYZ have a tax rate of 35%, and a debt beta of 0.

Is Canada Telecoms WACC the right discount rate for its new project? Why or why not? (5 marks)
Explain why you cannot use XYZs equity beta (1.05) as a proxy for the equity beta of Canada Telecoms new project. Estimate the new projects equity beta. (10 marks)
What is the new projects cost of capital? (5 marks)

Question 2

In March 2020, Snow Fun, Inc., made a rights issue at a subscription price of $10 a share. One new share can be purchased for every 3 shares held. Before the issue, there were 12 million shares outstanding, and the share price was $15.

(1) What is the total amount of new money raised? (2 marks)

(2) What is the expected stock price after the rights are issued? Why is the stock price expected to fall after the right issue? (10 marks)

(3) Suppose that the company had decided to issue the new stock at $8 instead of $10 a share, how many new shares would it have needed to raise the same sum of money? Show that Snow Funs shareholders are just as well off if it issues the shares at $8 a share rather than $10. (8 marks)