Interstate Transport Has a Target Capital Structure of 50% Debt

question 2

Multiple Choice

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 1.38.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 5%.The firm should:

• A)Reject the project; its return is less than the firm's required rate of return on the project of 16.9%.
• B)Accept the project; its return is greater than the firm's required rate of return on the project of 12.05%.
• C)Reject the project; its return is only 13%.
• D)Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt.
• E)Be indifferent between accepting or rejecting; the firm's required rate of return on the project equals its expected return.

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Definitions:

After-Tax Lease Payment

The lease payment amount after accounting for tax deductions or benefits.

Tax Rate

The percentage at which an individual or corporation is taxed.

CCA Rate

Capital Cost Allowance Rate, a tax deduction in some jurisdictions that reflects the depreciation of property, plant, and equipment.

CCA Class

In the context of Canadian tax, a classification for tax purposes that dictates the rate at which assets can be depreciated for tax deductions.