This is an asset beta versus equity beta question. Because the debt is almost risk free, we can use βDebt

≈ 0.

(a) First compute an unlevered asset beta for your comparable with its debt-to-asset ratio of 2 to 3. This is

βAsset

= wDebt . βDebt

+ wEquity . βEquity

= (2/3) . 0 + (1/3) . 2.5 ≈ 0.833. Next, assume that your project has the same asset beta, but a smaller debt-to-asset ratio of 1 to 3, and compute your own equity beta: βAsset

= wDebt . βDebt

+ wEquity . βEquity

⇒ 0.833 ≈ (1/3) . 0 + (2/3) . βEquity

⇒ βEquity

=

1.25.

(b) With an asset beta of 0.83, your firm’s asset hurdle rate should be E(˜ri) = 3% + 2% . 0.83 ≈ 4.7%.

(c) Your comparable’s equity expected rate of return would be E(˜rComps Equity) = 3% + 2% . 2.5 = 8%.

Your own equity’s expected rate of return would be E(˜rYour Equity) = 3% + 2% . 1.25 = 5.5%