Biomedical Inc. is contemplating entering into a new line of business that aims to manufacture vaccines for a rare but deadly tropical virus. The venture, to be called Xtreme, is expected to be highly lucrative but has much higher risk than Biomedical’s current line of business. In order to evaluate the project, Biomedical has identified a company, Pure-X of similar risk characteristics as the X-treme venture. Current market risk premium is 7% and risk free rate is 2%. Using the following information, determine the appropriate discount rate (WACC) for evaluating this new venture.
Biomedical: 50% debt financed; Equity Beta = 0.8; Corporate tax rate = 30%
Pure-X: 40% debt financed; Equity Beta = 2.2; Corporate tax rate = 35%
X-treme Venture: debt-to-equity of 1/3; Pre-tax cost of debt is 5%