Question

Suppose that your company is launching a new project. To estimate the cost of capital for the project
you search the market and find a company that has very similar risk characteristics to the project as follows:
Market capitalization, MVE =	$100.00	million
Market value of debt, D =	$50.00	million
Cost of debt, Rd =	5.00%
Cost of equity, Re =	15.50%
Corporate tax rate, t =	30%
Calculate the cost of capital of the project for the following two cases:
The project is equity financed.
The project is funded by both debt and equity and has the same leverage ratio (D/E) as does the comparable.

Answer 1

a.

cost of capital of the project if the project is equity financed is cost of equity that is 15.50%.

b.

The project is funded by both debt and equity and has the same leverage ratio then cost of capital of project would be WACC of company.

Market value of equity = $100 million

Market value of debt = $50 million

Total Value of capital = $150 million.
Weight of debt = 33.33%

Weight of equity = 66.67%

WACC is calculated below:

WACC = (66.67% × 15.50%) + (33.33% × 5%) × (1 - 30%)

= 10.33% + 1.17%

= 11.50%

WACC is 11.50%.