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:

Widespread Misstatements

False or misleading statements that are not isolated incidents but occur on a broad scale.

Family Resemblance Test

A legal test applied to determine whether a new financial instrument should be classified as a security under U.S. law.

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A significant court case that established a test for determining whether a transaction qualifies as a security under the securities laws.

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