Interstate Transport has a target capital structure of 50% debt and 50% common equity. The firm is considering a new independent project that has a return of 13% and is not related to transportation. However, a pure-play proxy firm has been identified that has a beta of 1.34. Both firms have a marginal tax rate of 40%, and Interstate's before-tax cost of debt is 12%. The risk-free rate is 10% and the market risk premium is 6%. The firm should:

Question

A. Be indifferent between accepting or rejecting; the firm's required rate of return on the project equals its expected return.
B. Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt.
C. Accept the project; its return is greater than the firm's required rate of return on the project of 12.62%.
D. Reject the project; its return is less than the firm's required rate of return on the project of 16.9%.
E. Reject the project; its return is only 13%.

Answer 1

Answer: C