Question
Suppose that you are the CFO of Mega Suites REIT (MSR). MSR currently has a capital structure of 20% debt-to-total assets ratio. You believe that
Suppose that you are the CFO of Mega Suites REIT (MSR). MSR currently has a capital structure of 20% debt-to-total assets ratio. You believe that more debt can be taken on, up to a limit of 35% debt, without losing the REITs ability to borrow at 3%, the prime rate (assumed to be the risk-free rate.) The REIT does not pay corporate tax. The expected return on the market is expected to be 12%, and the systematic risk of the companys equity, Levered, is estimated to be 0.7.
(a) What is MSRs current weighted average cost of capital? Its current cost of equity?
(b) What is MSRs unlevered beta?
(c) What will the new weighted average cost of capital be if the target capital structure is changed to 35% debt-to-total assets ratio?
(d) Should a shopping center project in LA with a 9% expected rate of return be accepted if its systematic risk, Levered, is the same as that of the firm?
(e) Suppose the new project in LA would have an operating cash flow with a systematic risk that is different from that of the firm. Based on estimates of comparable shopping centers, the unlevered beta is estimated to be 1.2. What rate of return must it earn in order to be profitable if MSR has
i. 20% debt in its capital structure?
ii. 35% in its capital structure?
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