SBS Corp. is considering the selection of two projects with the following internal rate of return

$($IRR$).$ The projects are not mutually exclusive.

Project Initial Investment $($RM$)$ IRR $(\%)$

Project A $25$ million $16$

Project B $25$ million $16\mathrm{.}5$

Total financing required $50$ million

SBS Board of Directors have agreed that new financing will be used to fund the projects. Currently

SBS has $30\%$ debt in its capital structure. The beta of the company at the current level of debt is

$1\mathrm{.}2.$ Net profit in the previous year amounted to RM$17$ million. The share holders expect some

dividends to be paid from the profit. The Board of Directors will consider paying dividends from

the net profit after all financing needs of the projects are fulfilled.

The risk$-$free rate which is based on an annual fixed deposit rate is $3\%$ while the expected return

of the market is $18\%.$ SBS currently is in the $30\%$ tax bracket. SBS made it a point to only make

investment decisions on projects with internal rate of return $($IRR$)$ higher than the cost of capital.

An investment banker has indicated that the interest rate will depend upon the percentage of debt

in the capital structure. The level of debt will also affect the beta of the company. The company is

eligible to borrow at the following interest rate.

Percentage of debt in the capital structure Interest Rate

$08\%$

$108\mathrm{.}25\%$

$208\mathrm{.}75\%$

$309\%$

$4010\%$

$5010\mathrm{.}5\%$

Loans more than $50\%$ of capital structure $11\%$

a$.$ Determine the appropriate capital structure to finance the project.