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Mermaid Coffee Corporation (MCC) has 1,000,000 shares of stock currently trading at $42 per share. The company has issued 20,000 bonds, each with market value $928.59 and yield to maturity 7%. MCC asset beta is 1.3, the risk free rate is 5%, and the expected market risk premium is 5%.
a. Assuming there are no corporate taxes, what is the firm's weighted average cost of capital (WACC)?
b. Now, assume that a 35% corporate tax rate applies to this firm. All of the information given in the introduction still applies, but your answer to part (a) doesn't necessarily apply. Recalculate the WACC under this assumption and state whether this firm would be willing to invest in a project that costs $1,000,000 today and that will have a net (after-tax) payoff of $1,240,000 exactly one year from now?
(You may assume the project is as risky as the rest of the firm)
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