1. Ant Chemicals (AC) is undertaking a new project that is substantially different from its current line of business. The project will be entirely equity financed and, in order to estimate the cost of...

checking of assignment answers


1. Ant Chemicals (AC) is undertaking a new project that is substantially different from its current line of business. The project will be entirely equity financed and, in order to estimate the cost of capital for the new project it identifies another company – Mouse Medicines – whose activities are very similar to the new project that AC is considering. Ant collects the following data on Mouse: If the riskless interest rate is 5% and the market risk premium is 6%, what discount rate should AC use in evaluating its new project? 2. A Incorporated (AI) is all-equity financed and has two divisions. The furniture division has an asset beta of 0.5, expects to generate free cash flow of $30 million in year 1 and has an expected (perpetual) growth rate of 3%. The fast food division has an asset beta of 1.4, also expects to generate free cash flow of $30 million in year 1 and has an expected (perpetual) growth rate of 5%. The riskless interest rate is 4%, the market risk premium is 6% and there are no taxes. i. Estimate the value of AI’s furniture division. ii. Estimate the value of AI’s fast food division. iii. Estimate AI’s current equity beta and overall cost of capital. iv. How useful is AI’s overall cost of capital for evaluating projects in the two divisions? 3. G Corporation (GC) currently has a debt-to-equity ratio of 0.80 and plans to maintain its debt-to equity ratio at this level in the future. It has an equity cost of capital of 14%, and a debt cost of capital of 9%. GC’s corporate tax rate is 45% and the market capitalization of its equity is £150 million. a. If GC’s free cash flow is expected to be £8.0 million next year, what constant expected future growth rate is consistent with the firm’s current market value? b. What would GC’s current market value be if, instead of maintaining a debt-to-equity ratio of 0.80, it were entirely equity financed? (Assume that the growth rate of the free cash flows is the same as you calculated in part (a)).