The McGregor company has the following capital structure information: Source of fund Market value (Smil) Debt Preferred Equity Ordinary Equity 0 100 Book value (Smily 100 50 03 50 12 200 150 The current risk-free rate on the market is 3% and the current market risk premium is 5%. Let assume there is no corporate tax. QUESTIONS 1. What is the company cost of capital given the above information? [3 marks] 2. McGregor is proposing a project that would require an initial investment of $860,000. The project is expected to generate $300,000 at the end of the first year, $500,000 at the end of the second year and $600,000 at the end of the third year. However, the company has realized that the market condition may be unstable in the next few years. To adjust for this uncertainty, McGregor chooses not to adjust the discount rate but rather assessing chances of failure for each year that no cash flow will be produced. The company expects a 20% chance of failure for the cash flow in year 1, 25% chance of failure for the cash flow in year 2 and 30% chance of failure for the cash flow in year 3. (Note that the success or failure of each cash flow is independent with others.) What is the Net Present Value (NPV) of the project with and without an assessment about the chances of failure for cash flows? Comment about how an assessment on changing project risk can affect the decision of a financial manager. (8 marks) 3. McGregor has changed its assessment for the project described in part 2. They ignore the chance of failure regarding the cash flows and assume that the project would have the average risk of the company's other investments. However, they would like to uncover what they are really assuming by using the Certainty Equivalent Cash Flow (CEO) approach. As an analyst in the company, you are required to work out the CEO, and deduction for risk along with the project life, and then give advice so that the top managers can assess. [7 marks]