Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The...
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Canada Telecom, a telephone company, is contemplating investing in a project in multimedia applications. The company is currently 30% debt financed. The companys analysts have estimated the projects cash flows but need to determine the project cost of capital. Canada Telecom analysts assess that their new multimedia division has a target debt-to-value ratio of 45%, and a cost of debt of 6.5%. In addition, the risk-free rate is 3%, and market risk premium is 5%.
XYZ Co. is a pure play in the multimedia business and is 35% debt financed. Its current equity beta is 1.05. Assume that both Canada Telecom and XYZ have a tax rate of 35%, and a debt beta of 0.
- Is Canada Telecoms WACC the right discount rate for its new project? Why or why not?
- Explain why you cannot use XYZs equity beta (1.05) as a proxy for the equity beta of Canada Telecoms new project. Estimate the new projects equity beta.
- What is the new projects cost of capital?
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