End User products Inc. is evaluating a project involving a speicalized software. It has established, after a careful study of the software industry, that PlagiSoftware could be used as a "Pure Play" to evaluate the project. PlagiSoftware is an established firm with a marginal tax rate of 40% and a debt ratio of 50%. The beta of Plagisoftware is found using the following Propability distribution, using the formula
Beta i= Covariance (i, Market Portfolio)/Variance of Market Portfolio
State Probability Returns (%)
Plagisoftware Market
Recession .25 6 12
Normal .50 15 16
Boom .25 24 20
End user will have a debt/equity ratio of 2/3 and a marginal tax rate of 20%. Its before tax cost of debt is 10%. The risk free rate of return is 6% and the required return on the market portfolio is 16%. End-User has determined the IRR if the project to be 18%. The beta of End-User without the new project is 1.8.
a. What is the levered beta of Plagisoftare found from the profitability distribution given above.
b. What is the business risk beta of plagisoftware using hamada model
C. if end user were to use plagisoftware as pure play for the project using its own leverage, what is the levered beta of the project for the end user using hamada model.
d. what is the cost of equity for the levered project for end user using CAPM/SML Equation
e. what is the WACC for the levered project for End-User?
f. Should End-user accep or reject the project. Why?