Cascade Water Company (CWC) currently has 30,000,000 shares of common stock outstanding

that trade at a price of $42 per share. CWC also has 500,000 bonds outstanding that currently

trade at $923.38 each. CWC has no preferred stock outstanding and the beta of its common stock

is 2.639. The risk-free rate is 3% and the required return on the market is 12.5%. The firm's bonds have 20 years to maturity, a $1,000 par value, a 10% annual coupon rate with semiannual

coupons.

CWC is considering adding to its product mix a healthy bottled water geared toward children.

The initial outlay for the project is expected to be $3,000,000 which will be depreciated using the

straight-line method to a zero salvage value, and sales are expected to be 1,250,000 units per year

at a price of $1.25 per unit. Variable costs are estimated to be $0.24 per unit, and fixed costs of

the project are estimated at $200,000 per year. The project is expected to have a 3-year life and a

terminal value (excluding the operating cash flows for year 3) of $500,000. CWC has a 34% tax

rate. For purposes of this project, working capital effects will be ignored. Bottled water targeted

at children is expected to have different risk characteristics from the firm's current products.

Therefore, CWC has decided to look for other firms with products similar to the proposed project.

They have identified the following two firms and their common stock betas.

 

Firm Beta

Fruity Water 1.72

Ladybug Drinks 1.84

 

Assignment

1. Determine the current weighted average cost of capital for CWC. Remember to show

you calculations in finding the different components of WACC: financing proportions,

component costs of capital.

2. Determine the appropriate cost of capital for the healthy bottled water project using the

average of the betas for the two companies above as the beta for calculating the cost of

common stock. Leave your other cost of capital components from #1 the same.

3. What are the expected cash flows for the healthy water project?

4. Should CWC under take the healthy water project? Support your conclusion