Problem
Tessier-Ashpool S.A. has an unlevered beta of 1.2, a debt to equity ratio of 2, a tax rate of 21%, and a cost of debt of 14%. The expected return on an S&P 500 index fund is 19% and the riskless rate is 6%. Tessier-Ashpool has a single project available to them with an initial cost of $100M. If this project succeeds, it will produce a yearly EBIT of $100M in perpetuity. If it fails, it will be worthless. There is a 90% chance this project will fail.
a) What is the Flows to Equity value of this project? You may assume that Tessier-Ashpool is borrowing 75% of the initial costs of the project in perpetual debt.
b) Under what circumstances might Tessier-Ashpool shareholders be in favor of this project?