Reference no: EM132719851

A firm's target capital structure is 40 percent debt and 60 percent common equity. The firm's common stock has just paid a dividend of $2.20 per share. It is expected that the dividends of this firm will grow at a rate of 5 percent per year in the future. The current price of the common shares is $20. If new common shares are issued, it will be necessary to incur flotation costs of $2 per share. The firm's bonds have a par value of $1,000; a coupon rate of 6 percent paid annually; 12 years to maturity; and currently sell for $980 each. Flotation costs on similar new bonds would be 3 percent of the par value on an after-tax basis. The firm is considering a project with an investment of $10 million. The firm doesn't have enough cash for the investment and will have to issue common shares to raise the $10 million.

What is the required rate of return on this investment if the firm's tax rate is 40 percent and the project has the same level of risk as the firm?