1. Your firm is planning to invest in an automated packaging plant. Xanadu Industries is an all-equity firm that specializes in this business. Suppose Xanadus equity beta is 0.85, the risk-free rate is 4%, and the market risk premium is 5%. If your firms project is all equity financed, estimate its cost of capital.
2. Next, You find a firm, Kiliminjaro Design, which is also engaged in a similar line of business. This is a better comparable firm. Kiliminjaro has a stock price of $20 per share, with 15 million shares outstanding. It also has $120 million in outstanding debt, with a yield on the debt of 4.5%. Kiliminjaros equity beta is 1.00. Assume Kiliminjaros debt has a beta of zero. Estimate Kiliminjaros unlevered beta. Use the unlevered beta and the CAPM to estimate Kiliminjaros unlevered cost of capital.

C. Estimate Kiliminjaros equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield, and using these results, estimate Kiliminjaros unlevered cost of capital.

D. Explain the difference between your estimates in part (b) and part (c).