The Z Energy Corp. has a new investment opportunity that generates cash flows of $6 million per year (in expectation) forever. The managers of Z Energy are not sure what the required rate of return for the project should be, so they examine W Energy Corp. whose main business is very similar to the new project Z Energy is evaluating. The expected market risk premium is 8.5%, and the risk-free rate is 1%. The of the equity of W Energy Corp. is 0.7. W Energy has $160 million of equity and $20 million of debt in its capital structure. The debt of W Energy has a of approximately 0. The tax rate is 21%, but there are no personal income taxes on either debt or equity. Ignore bankruptcy costs. a. What is the of the assets of W Energy Corp.? b. What is the expected return of the assets of W Energy Corp.? c. What is the present value of the cash flows of the project, on the assumption that Z Energy will not issue any new debt to finance the project? d. Now assume that Z Energy Corp. will issue $2 million in debt to help finance the project. It 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, Z Energy Corp. is highly profitable, and will certainly be able to receive the benefit of the tax deductibility of interest payments. What is the adjusted present value of the project under these assumptions? e. If the project requires an investment of $40 million, should Z Energy go ahead with it? Explain briefly.

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