1. Consider the following data in connection with financing a project.

Investment = $150 million; Debt !"#it$ = %0&0; 'sef#l life of the project = & $ears
Interest ( principal pa$ment at the end of each $ear = $)* million
Cash flow after ta+ at the end of the first $ear = $,5 million
Cash flow after ta+ at the end of the second $ear = $110 million; -a+ rate = .5/
0is12free rate of ret#rn = %/; 0et#rn on the mar1et portfolio = &5/; 3eta = 1.5
4a5 Determine the cost of debt 4ass#ming that net proceeds = gross proceeds56 cost of e"#it$
4#sing the Capital 7sset 8ricing 9odel5 and the :eighted 7verage Cost of Capital
4:7CC5. Chec1 the economic viabilit$ of the project.
4b5 !+plain the #nderinvestment problem and verif$ whether the problem e+ists in this
project financing sit#ation.
4c5 Consider the following brea12#p of costs and reven#es 47ll fig#res are in $ million5.
;ear
0 1 &
Capital cost
<and &0 2 2
8lant = 9>C ,5 &5 2
D#ties>-a+es 15 10 2
?thers @0 .5 2
-otal 150 ,0 2
?perating cost 2 110 &00
-otal cost 150 1%0 &00
0even#e 2 &55 .10
Cash flow 2150 ,5 110
Aow6 if 4i5 the present val#e of the agric#lt#ral o#tp#ts from the ac"#ired land d#ring the
#sef#l life of the project is $.0 million6 4ii5 &0/ of the landed costs of the plant and m>c
is attrib#ted to import d#ties6 and 4iii5 the import of the project o#tp#t wo#ld have been
10/ cheaper6 determine whether the project is sociall$ desirable ass#ming a social rate of
disco#nt of 1&/.
Bol#tion 4a5 Cost of debt = *.%/6 Cost of e"#it$ = ...5/6 :7CC = 11.%/6
A8CD11.%/ = 5.0* E 06 so6 project is economicall$ viable. 4b5 FCF1 = )6 FCF& =
@16 A8CD...5/ = 2&.5 G 06 so6 #nderinvestment problem e+ists. 4c5 A8CD1&/
4Bocial rate of disco#nt5 = 2*.@. G 06 so6 project is not sociall$ desirable.