his project will require $14 million initial investment and is expected to generate volatile cash flow during the first three years. It is expected to generate volatile cash flow the three first years. Cash grow is expected to grow at a constant rate of 3% per year after year four . The company's current balance sheet is $2 billion debt in book value and the debt is trading at 80% of book value. The debt beta is 0.6 the market value of equity of the company is 4.8 billion and the equity beta is 1.75. It has been stable and the company will issue ten million new debt at the current borrowing cost to take the new investment project. The company plans to gradually reduce borrowing in the first 3 years and then return to its previous stable capital structure. Debt repayment schedule is given below. Assume the corporate tax rate is 21%. Suppose the risk free rate is 2% and the market risk return is 10%. The underwritten charges of 1.5% of the debt issue as their total commission. One through three years after tax cash flow estimated are given Cashflow forecast in $M 0 1 2 3 After tax cash flow -14.0 2.0 3.0 3.7 Debt Balance at yr end ($M) 10.0 9.0 8.5 6.5 What is the unlevered beta of the company and the return on assets? Calculate the levered cost of capital (return on equity) and after-tax WACC for peri with stable capital structure.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
This project will require $14 million initial investment and is expected to generate volatile cash flow during the first three years. It is expected to generate volatile cash flow the three first years. Cash grow is expected to grow at a constant rate of 3% per year after year four . The company's current balance sheet is $2 billion debt in book value and the debt is trading at 80% of book value. The debt beta is 0.6 the market value of equity of the company is 4.8 billion and the equity beta is 1.75. It has been stable and the company will issue ten million new debt at the current borrowing cost to take the new investment project. The company plans to gradually reduce borrowing in the first 3 years and then return to its previous stable capital structure. Debt repayment schedule is given below. Assume the corporate tax rate is 21%. Suppose the risk free rate is 2% and the market risk return is 10%. The underwritten charges of 1.5% of the debt issue as their total commission. One through three years after tax cash flow estimated are given
Cashflow
After tax cash flow -14.0 2.0 3.0 3.7
Debt Balance at yr end ($M) 10.0 9.0 8.5 6.5
What is the unlevered beta of the company and the
- Calculate the levered cost of capital (
return on equity ) and after-tax WACC for peri with stable capital structure.
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