National Electric Company (NEC) is considering a $45.05 millionproject in its power systems division. Tom Edison, the company’schief financial officer, has evaluated the project and determinedthat the project’s unlevered cash flows will be $3.15 million peryear in perpetuity. Mr. Edison has devised two possibilities forraising the initial investment: Issuing 10-year bonds or issuingcommon stock. The company’s pretax cost of debt is 7.4 percent, andits cost of equity is 11.3 percent. The company’s targetdebt-to-value ratio is 80 percent. The project has the same risk asthe company’s existing businesses, and it will support the sameamount of debt. The tax rate is 40
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