Your firm is planning to invest in an automated packaging plant. Harburtin Industries is anâ all-equity firm that specializes in this business. Supposeâ Harburtin's equity beta is 0.83â, theâ risk-free rate is 5%â, and the market risk premium is 6%.
a. If yourâ firm's project isâ all-equity financed, estimate its cost of capital. After computing theâ project's cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a secondâ firm, Thurbinarâ Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $18 perâ share, with 15 million shares outstanding. It also has $110 million in outstandingâ debt, with a yield on the debt of 4.4%. âThurbinar's equity beta is 1.00.
b. Assumeâ Thurbinar's debt has a beta of zero. Estimateâ Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimateâ Thurbinar's unlevered cost of capital.
c. Estimateâ Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using theseâ results, estimateâ Thurbinar's unlevered cost of capital.
d. Explain the difference between your estimate in part â(bâ) and part â(câ).
e. You decide to average your results in part â(bâ) and part â(câ), and then average this result with your estimate from part â(aâ). What is your estimate for the cost of capital of yourâ firm's project?
a. If yourâ firm's project isâ all-equity financed, estimate its cost of capital.
The projectâs cost of capital is ?? %. (Round to two decimal places.)
b. Assumeâ Thurbinar's debt has a beta of zero. Estimateâ Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimateâ Thurbinar's unlevered cost of capital.
Thurbinar's unlevered beta is ??.
Thurbinar's unlevered cost of capital is ?? %.
c. Estimateâ Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using theseâ results, estimateâ Thurbinar's unlevered cost of capital.
Thurbinar's equity cost of capital is ??%
Thurbinar's unlevered cost of capital is ??%
d. Explain the difference between your estimate in part â(bâ) and part â(câ).
A. The answers are actually the same; any difference is just due to rounding errors.
B. The answers are differ because we are using approximations rather than formulas that hold exactly.
C. In the first case, we assumed the debt had a beta of zero so we assumed the cost of debt was the riskless rate, while in the second case we assumed the cost of debt was the yield to debt.
D. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.
e. You decide to average your results in part â(bâ) and part â(câ), and then average this result with your estimate from part â(aâ). What is your estimate for the cost of capital of yourâ firm's project?
The average unlevered cost of capital from part â(bâ) and part â(câ) is ?? %.
The average unlevered cost of capital from part â(bâ) and part â(câ) with part â(aâ) is ??%
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is anâ all-equity firm that specializes in this business. Supposeâ Harburtin's equity beta is 0.83â, theâ risk-free rate is 5%â, and the market risk premium is 6%.
a. If yourâ firm's project isâ all-equity financed, estimate its cost of capital. After computing theâ project's cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a secondâ firm, Thurbinarâ Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $18 perâ share, with 15 million shares outstanding. It also has $110 million in outstandingâ debt, with a yield on the debt of 4.4%. âThurbinar's equity beta is 1.00.
b. Assumeâ Thurbinar's debt has a beta of zero. Estimateâ Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimateâ Thurbinar's unlevered cost of capital.
c. Estimateâ Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using theseâ results, estimateâ Thurbinar's unlevered cost of capital.
d. Explain the difference between your estimate in part â(bâ) and part â(câ).
e. You decide to average your results in part â(bâ) and part â(câ), and then average this result with your estimate from part â(aâ). What is your estimate for the cost of capital of yourâ firm's project?
a. If yourâ firm's project isâ all-equity financed, estimate its cost of capital.
The projectâs cost of capital is ?? %. (Round to two decimal places.)
b. Assumeâ Thurbinar's debt has a beta of zero. Estimateâ Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimateâ Thurbinar's unlevered cost of capital.
Thurbinar's unlevered beta is ??.
Thurbinar's unlevered cost of capital is ?? %.
c. Estimateâ Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using theseâ results, estimateâ Thurbinar's unlevered cost of capital.
Thurbinar's equity cost of capital is ??%
Thurbinar's unlevered cost of capital is ??%
d. Explain the difference between your estimate in part â(bâ) and part â(câ).
A. The answers are actually the same; any difference is just due to rounding errors.
B. The answers are differ because we are using approximations rather than formulas that hold exactly.
C. In the first case, we assumed the debt had a beta of zero so we assumed the cost of debt was the riskless rate, while in the second case we assumed the cost of debt was the yield to debt.
D. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.
e. You decide to average your results in part â(bâ) and part â(câ), and then average this result with your estimate from part â(aâ). What is your estimate for the cost of capital of yourâ firm's project?
The average unlevered cost of capital from part â(bâ) and part â(câ) is ?? %.
The average unlevered cost of capital from part â(bâ) and part â(câ) with part â(aâ) is ??%