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Evaluating projects: market risk and decision making

BACKGROUND:

Ponza International has three divisions. One is engaged is leisure wear, one in graphics, and one in household paint. The company has identified proxy companies in these lines of business whose stocks are publicly traded. Neither Ponza International nor the proxy companies employ debt in their capital structures. Ponza has estimated that the systematic risks of its three divisions are as follows:

Leisure Graphics Paint
Beta: 1.16 1.64 0.70

The expected market risk premium is 8%, the current T-bill rate is 7%, the yield on A-rated corporate debt is 9.3% (If Ponza issues debt it would be A-rated), and inflation is expected to remain at 3.2% for the foreseeable future.. The divisions are evaluating a number of projects, which have the following expected returns:

Project Division Expected Return
1 Leisure 26%
2 Graphics 18%
3 Paint 12
QUESTIONS:

1) Identify the projects Ponza International should accept. Explain. Think NPV and returns.

2) If all divisions of Ponza International have a debt/total asset ratio of 40%, that it considers optimal, and a marginal tax rate of 40%, identify the projects Ponza International should accept. Explain. Think unlevered Beats, WACC, NOV, cost of equity..etc

CAN YOU HELP??? I'm lost....

Solution Preview

See attached file where formatting is conserved:
Ponza International has three divisions. One is engaged is leisure wear, one in graphics, and one in household paint. The company has identified proxy companies in these lines of business whose stocks are publicly traded. Neither Ponza International nor the proxy companies employ debt in their capital structures. Ponza has estimated that the systematic risks of its three divisions are as follows:

Beta:
Leisure 1.16
Graphics 1.64
Paint 0.7

The expected market risk premium is 8%, the current T-bill rate is 7%, the yield on A-rated corporate debt is 9.3% (If Ponza issues debt it would be A-rated), and inflation is expected to remain at 3.2% for the foreseeable future.. The divisions are evaluating a number of projects, which have the following expected returns:

Project Division Expected Return
1 Leisure 26%
2 Graphics 18%
3 Paint 12%

QUESTIONS:

1) Identify the projects Ponza International should accept. Explain. Think NPV and returns.

2) If all divisions of Ponza International have a ...

Solution Summary

The solution identifies projects that the company should accept when it is unlevered and when it has debt on its books.

$2.19