Required:

a. Assume the market value of Maxy Corp.'s ordinary equity, preferred equity and debt are $7 billion, $4 billion and $10 billion respectively. The firm has a beta of 1.4, the market risk premium is 6% and the risk-free rate of interest is 4%. The firm's preferred stock pays a dividend of $3 each year and trades at a current price of $25 per share. The firm's debt trades with a current yield to maturity of 8.5%. The firms marginal tax rate is 35%.

i. What is the firm's cost of ordinary equity? [1 mark]

ii. What is the firm's weighted average cost of capital? [3 marks]

b. 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 projects leverage and to maintain the projects 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 projects effective after-tax WACC be with the addition of leverage?

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.