In the past year, Fortescue Metals Group (FMG) has benefited from increases in the price of iron ore along with reduction in the cost base. Management has asked you to evaluate a series of projects where the decision criteria requires that accepted projects generate a return that is 5% greater than the WACC. The following data was gathered as of May 2017:
Corporate tax rate = 30%
Current stock price = $5.12
Long-term debt outstanding = $4.5 billion
Yield to maturity on long-term debt = 4.75%
Treasury bill rate = 1.75%
Expected return on market portfolio = 8.25%
Beta of common stock = 1.7
Book value of common stock = $1.3 billion
Number of shares outstanding = 2,890,625,000
Establish the minimum return required for projects to be accepted by FMG.
With reference to the theory covered in class, explain why it is not common to see firms with a capital structure of 100% debt, and provide an example of a firm that would be likely to have a high proportion of debt.