1) Estimate the WACC that is appropriate for discounting the Collinsville plant’s incremental cash flows. You should estimate and present each component of the WACC separately, explaining briefly but clearly what assumptions you are making for each of them. In the same spirit, estimate the appropriate all-equity cost of capital for the APV-based valuation.

WACC calculation.
WACC = RD*(1-t)*D/(D+E)+RE* E/(D+E)
Cost of equity
We assume that risk free rate (Rf) equals rate of long-term Treasury Bonds (as the project’s life is 10 years), so Rf = 9.5%.

According to Aswath Damodaran equity risk premium in the US in 1979 was 6.45%, thus
Rm – Rf = 6.45%.

We will estimate beta equity using data of comparable firms, focusing on …show more content…

Do they differ and how much? If the difference is important, explain why. If the difference is small or zero, explain why.

To use the APV model we need to calculate the value of the project as if it were 100% equity financed (for this we use the return on equity obtained in question 1 – 15.56%) and the value of the tax shield of debt.
For the first we arrive at an NPV of $9.023 million. The calculations are shown below:

| 1979 | 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 1989 | FCF | | 1,206 | 1,407 | 1,892 | 2,074 | 2,073 | 2,116 | 2,163 | 2,213 | 2,264 | 2,318 | WACC | | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | 15.56% | Disc. Rate | | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | 1.1556 | no