Question

Piedmont Hotels is an all-equity company. Its stock has a beta of 1.17. The market risk premium is 6.6 percent and the risk-free rate is 2.4 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.6 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

Multiple Choice

• 8.52%

• 8.91%

• 10.12%

• 7.31%

• 11.72%

Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt–equity ratio of .83. The cost of equity is 12 percent and the pretax cost of debt is 6.8 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 35 percent?

Multiple Choice

• .5917

• .5186

• .5464

• .4536

• .6182

The required return on the stock of Moe's Pizza is 12.5 percent and aftertax required return on the company's debt is 3.91 percent. The company's market value capital structure consists of 69 percent equity. The company is considering a new project that is less risky than current operations and it feels the risk adjustment factor is minus 1.8 percent. The tax rate is 35 percent. What is the required return for the new project?

Multiple Choice

• 11.21%

• 8.04%

• 7.61%

• 9.84%

• 11.64%

Answer 1

Cost of equity = Risk free rate + Market risk premium * beta

                          =2.4% + 6.6% * 1.17

                           = 10.12%

Required rate of return for the project = 10.12% -1.6% = 8.52%

Capital weight of equity = 1/(1+.83) = .5464

WACC = 69% * 12.5% + 31% *3.91% = 9.84%

required return for the new project = 9.84% - 1.8% = 8.04%