Question 9 The Zephyr Company desires to estimate a cost of capital for a new in

Question

Question 9 The Zephyr Company desires to estimate a cost of capital for a new investment project. Since the project is not in the company?s current line of business, the financial analyst at Zephyr gathers the following pure play data. (Note: All pure plays have target leverage ratio policies.) Zephyr?s tax rate is 27 percent and it desires a debt-to-equity ratio of 1 .25 for its new investment project. The financial analyst estimates that the risk-free rate is 7 percent and the market risk premium is 8 percent. Compute an estimate of the unlevered cost of capital (ru) for Zephyr? s new project. Also compute the WACC for Zephyr?s new project, assuming Zephyr has a debt beta of zero.

Explanation / Answer

RU= RF+u(Rm-Rf)

       =7+ 0*(8-7)   

   =7%

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