Texas Chemicals is a major producer of oil-based fertilisers in the US. The companyAc€?cs stock is currently selling for $80 per share and there are 10 million shares outstanding. The company also has debt outstanding with a market value of $400 million. The companyAc€?cs current capital structure approximates well its target position. The companyAc€?cs equity beta is equal to 2.0.
The company is considering an expansion project which is expected to generate a rate of return of 20% annually. Assuming a corporate tax rate of 50%, a risk free rate of 8%, and the expected rate of return on the market portfolio of 17%, determine whether the company should go ahead with the project under the following scenario:
The projectAc€?cs risk is different (larger) from that of the company. The projectAc€?cs unlevered beta is 2.5. Also, consistent with its higher risk level, the project is expected to generate a rate of return of 25%. Further, as a result of the projectAc€?cs higher risk level, the company has decided to use a more conservative capital structure represented by a debt-to-asset ratio of 15%.