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EZ-lumber is considering an investment of $40 million in plant and machinery. This is expected to produce free cash flows of $13 million in year 1, $14 million in year 2, $15 million in year 3, and 25 million in year 4. The tax rate is 35%. You don’t know the target capital structure, but you do have the following information:
• Bonds: The target capital structure has $36,000,000 in debt. The firm’s existing bonds have a face value of $1000, a coupon rate of 5.5% with coupons paid annually, 8 years to maturity and a price of 967.
• Retained Earnings (Internal Equity): There are 1,000,000 shares outstanding with a price of $60 per share. The beta on the stock is 1.25. The risk-free rate is 2.5% and the market risk premium is 6%.
Find the internal rate of return (IRR) for the project. Using the WACC and IRR, should they invest? Why or why not?
COLLAPSE From the standpoint of the borrower; is long term or short term credit riskier? Would it ever make sense to borrow on a short term basis if short term rates were above long term rates?
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