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FIN351: lecture 6

FIN351: lecture 6

A summary example

John Cox, a recent MBA student of SFSU, was asked by his boss  in Geothermal to decide whether the firm should take an expansion project: the cost of the project is $30 million, and the project is expected to generate a perpetual incremental cash flow of $4.5 million. Currently, Geothermal has 20 million shares of common stocks outstanding, with a market price of $22.65 per share. The Beta of the firm’s equity is 1.1. The risk free rate is 4% and the market risk premium is 5.6%. The firm also has long-term debt, with the YTM of 9%. John also got the following information from the firm’s balance sheet:

Debt (12 years maturity, 8% coupon): $200 million

Common stocks:$110 million

If the tax rate is 35%, should John suggest to his boss to take the project or not?

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