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 0.83​, 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 $24 per​ share, with 15 million shares outstanding. It also has $104 million in outstanding​ debt, with a yield on the debt of 4.8%. ​Thurbinar's equity beta is 1.00.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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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 0.83​, 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 $24 per​ share, with
15 million shares outstanding. It also has $104 million in outstanding​ debt, with a yield on the debt of 4.8%. ​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?
 
 

 

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