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Question 6 : Cost of Capital ( 6 0 points ) Makita Inc. is a tool company. Recently, its stock has been added to the
Question : Cost of Capital points
Makita Inc. is a tool company. Recently, its stock has been added to the list of overthecounter stocks traded in the US Its equity beta is estimated to be
Makita is considering investing in a kitchen appliance business. The business project will
require an initial investment of $ If accepted, the kitchen appliance business will
represent of Makita's assets.
There is a chance the project will generate an annual payoff of $ forever, a
chance of an annual payoff of $ forever, and a chance that the project will
be a complete flop and generate no cash. Assume these are aftertax cash flows.
A firm investing solely in the kitchen appliance business pure play has an equity beta of
Suppose the pure play company has debt and equity.
Makita currently has debt and equity, and will maintain the same capture
structure for the new kitchen appliance business.
Makita forecasts that the return on the market portfolio Rm will be and the Treasury
bill rate Rf will be Suppose both Makita and the pure play company hold riskfree
debts. The corporate tax rate is
a What is Makitas overall cost of capital WACC before taking the project?
b What is the internal rate of return IRR of the kitchen appliance project? Hint: IRR is
the discount rate that sets NPV equal zero
c What is the appropriate cost of capital for the kitchen appliance project?
d Based on your answers to part b and part c should Makita accept the kitchen appliance
project? Why?
e What is Makita's overall cost of capital after taking the kitchen appliance business
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