Rice Energy Inc. is considering a project to explore natural gas liquids. It requires a $10

million investment and offers a level pre-tax cash flow of $2.25 million forever. The

market risk of this project is similar to the market risk of the projects taken by Apache

Corp. Assume that the debt rate of Apache is 3% and the beta of debt is zero. Also, the

debt level is kept the same forever. The marginal tax rate of Apache is 21%. Ignore

Bankruptcy costs.

a. Suppose the project is 100% equity finance, what is the cost of capital of the

project? What is the NPV of the project? Would you invest in the project?

b. Suppose the project is financed with $5 million of debt and $5 million of equity.

The debt rate is 4%. Rice Energy plans to keep the same level of debt forever.

The new debt issuance does not significantly increase the probability of

bankruptcy, nor introduce any agency/incentive problems. Furthermore, Rice

Energy is highly profitable, and will certainly be able to receive the benefit of the

tax deductibility of interest payments. What is the adjusted net present value of

the project under these assumptions?