The Stroud Drilling Company
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1) The Stroud Drilling Company from Stroud, Oklahoma is considering expanding into the mobile home business. The company is currently unlevered, but has a target debt/equity ratio of 0.2. It plans on paying for the project out of the cash from a new bank loan with an 8% interest rate (its marginal pre-tax cost of debt). Its current beta is 1.2. It has identified a pure play company in the mobile home business that is also unlevered, and has an equity beta of 1.5. Assume that the risk-free rate is 5%, the market risk premium is 6%, and all firms face a marginal tax rate of 30%. What discount rate should the Company use for the mobile home project?
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The relevant beta for the project is 1.5 (Beta of a pure play company in the mobile home business that is unlevered).
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