Problem
Walmart. has an unlevered beta of 1.2, a debt to equity ratio of 2, a tax rate of 21%, and a cost of debt of 14%. The expected return on an S&P 500 index fund is 19% and the riskless rate is 6%. Walmart has a single project available to them with an initial cost of $100M. If this project succeeds, it will produce a yearly EBIT of $100M in perpetuity. If it fails, it will be worthless. There is a 90% chance this project will fail.
i. What are Walmart's levered and unlevered costs of equity?
ii. What is the Flows to Equity value of this project? You may assume that Walmart is borrowing 75% of the initial costs of the project in perpetual debt.
iii. Under what circumstances might Walmart shareholders be in favor of this project?