(a) The new project’s value is $11/1.15 ≈ $9.57. At a cost of $10, the net present value is −$0.43.

(b) The value today of the new project is $11/1.15 ≈ $9.57. Therefore, the weight of the new project is wnew

= PVnew/PVcombined

≈ $9.57/$109.48 ≈ 8.74%.

(c) The beta of the combined firmis βcombined

= wold . βold

+ wnew . βnew

≈ 91.26% . 0.5 + 8.74% . 3 ≈

0.719.

(d) The combined cost of capital according to the CAPM is E(˜rcombined) ≈ 3% + 4% . 0.719 = 5.876%.

(e) Yes! The IRR of new is 10%. (For IRR, see Chapter 5, page 90.) 10% is above the blended cost of capital of 5.876%.

(f) The firm value would be

Again, you conclude that the firm has destroyed $0.43.

Transcribed Image Text:

PV = E(new) + E(Cold) 1 + (combined) ~ $105 + $11 $109.57 1 + 5.876%