Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.81, the risk-free rate is 5%, and the market risk premium is 5%.
a. If your firm's project is all-equity financed, estimate its cost of capital.
After computing the 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 second firm, Thurbinar Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $16 pershare, with 16 million shares outstanding. It also has $101 million in outstanding debt, with a yield on the debt of 4.2%. Thurbinar's equity beta is 1.00
b. Assume Thurbinar's debt has a beta of zero. Estimate Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar's unlevered cost of capital.
c. Estimate Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using these results, estimate Thurbinar's unlevered cost of capital.
d. Explain the difference between your estimate in part (b) and part (c).
e. You decide to average your results in part (b) and part (c), and then average this result with your estimate from part (a). What is your estimate for the cost of capital of your firm's project?
QUESTIONS:
A. If your? firm's project is all-equity financed, estimate its cost of capital. The project's cost of capital is _____%. (Round to two decimal places.)
B. Assume Thurbinar's debt has a beta of zero. Estimate Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar's unlevered cost of capital.
Thurbinar's unlevered beta is ____ ? (Round to two decimal places.)
Thurbinar's unlevered cost of capital is ____%. ?(Round to two decimal places.)
C. Estimate Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using these results, estimate Thurbinar's unlevered cost of capital.
Thurbinar's equity cost of capital is ______?%.(Round to two decimal? places.)
Thurbinar's unlevered cost of capital is ______%.(Round to two decimal? places.)
D. Explain the difference between your estimate in part (b) and part (c). (Select the best choice below.)
A. 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 on debt.
B. The answers are actually the same; any difference is just due to rounding errors.
C. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.
D. The answers differ because we are using approximations rather than formulas that hold exactly.
E. You decide to average your results in part (b) and part (c), and then average this result with your estimate from part (a). What is your estimate for the cost of capital of your firm's project?
The average unlevered cost of capital from part (b) and part (c) is ____?%. (Round to two decimal places.)
The average unlevered cost of capital from part (b) and part (c) with part (a) is _____?%. (Round to two decimal? places.)