The board of directors of Milan plc always uses the Adjusted Present Value technique to evaluate projects. The board is worried that the company's cost of capital is too high. It currently has risk-free debt with a market value of 25m and equity with a value of 100m. Its closest competitor, Hilton plc, has risk-free debt valued at 50m and equity valued at 125m, and has recently published some financial statements claiming to have an 'optimal leverage (gearing) ratio, delivering a weighted average cost of capital (WACC) of about 12.7%, and a cost of equity equal to 16.4%. The risk-free rate of interest is 5% and the equilibrium expected return on the market portfolio is believed to be 17%. Hilton's marginal rate of corporation tax is 30% and Milan's is 25% The cost of capital is of particular interest to Milan's board because it is about to try and raise funds for a new project, which will have the same operating risk as the current company. The project requires an initial investment of 20m, all of which will be raised by issuing shares, since the chairman does not like borrowing money. He argues that the company has a lower debt burden than Hilton, so Milan's gearing ratio must be better. The board expects the project to generate annual pre-tax cash inflows of 4m in perpetuity, starting 1 year after the initial investment. a) Assuming that Modigliani and Miller's theorems apply, and that Hilton's financial characteristics are equilibrium values, calculate the equilibrium cost of equity and WACO of Milan plc. b) Estimate the effect of the new project on Milan plc's shareholders' wealth. c) Explain what is meant by an 'optimal leverage ratio and discuss the effects of a lower level of debt on a company's WACC