Problem:
The TT Company is planning to put a manufacturing facility in place to build telescopes. The systematic risk of this project alone is 25% greater than those currently manage. The company has a capital structure in which 35% of the firm value is debt on which they pay 14% interest. The beta of its equity is currently .8 and the company faces a 36% tax rate. The initial investment cost is $4,200,000 and the expected cash flows after tax are $1,200,000 per year for 6 years. The manufacturing assets in question fall into CCA class 43 (30% CCA rate), assume that there is the 1 first year rule and ignore the value that is left in the 2 UCC pool at the end of the project. Lastly, TT will need an investment of $100,000 for inventory and another $100,000 to finance accounts receivable.
If the risk-free rate is 5% and you believe a historical market risk premium of 8.5% is a reasonable estimate, would you recommend TT to undertake this project?