Question
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is anall-equity firm that specializes in this business. SupposeHarburtin's equity beta is
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is anall-equity firm that specializes in this business. SupposeHarburtin's equity beta is 0.85
0.85, therisk-free rate is 3 %
3%, and the market risk premium is 6 %
6%.
a. If yourfirm's project isall-equity financed, estimate its cost of capital.
After computing theproject's cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a secondfirm, ThurbinarDesign, which is also engaged in a similar line of business. Thurbinar has a stock price of $ 24
$24 pershare, with 14
14 million shares outstanding. It also has $ 102
$102 million in outstandingdebt, with a yield on the debt of 4.3 %
4.3%. Thurbinar's equity beta is 1.00
1.00.
b. AssumeThurbinar's debt has a beta of zero. EstimateThurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimateThurbinar's unlevered cost of capital.
c. EstimateThurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using theseresults, estimateThurbinar's unlevered cost of capital.
d. Explain the difference between your estimate in part (b) and part (c).
e. You decide to average your results in part (b) and part (c), and then average this result with your estimate from part (a). What is your estimate for the cost of capital of yourfirm's project?
a. If yourfirm's project isall-equity financed, estimate its cost of capital.
Theproject's cost of capital is
nothing
%. (Round to two decimalplaces.)
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