firm is considering a project that will generate perpetual after-tax cash flows

Question

firm is considering a project that will generate perpetual after-tax cash flows of $22,000 per year beginning next year. The project has the same risk as the firm's overall operations and must be financed externally. Equity flotation costs 13 percent and debt issues cost 6 percent on an after-tax basis. The firm's D/E ratio is 0.7 What is the most the firm can pay for the project and still earn its required return? (Do not round intermediate calculations. Round your final answer to the nearest whole dollar.) Maximum the firm can pay Hints References eBook & Resources

Explanation / Answer

Cost of Equity = 13%
Aftertax Cost of Debt = 6%
D/E = 0.7

WACC = Weight of Debt*Aftertax Cost of Debt + Weight of Equity*Cost of Equity
WACC = (0.7/1.7) * 6% + (1/1.7) * 13%
WACC = 10.12%

Aftertax Cost Flows = $22,000

Cost of Project = Aftertax Cost Flows / WACC
Cost of Project = $22,000 / 0.1012
Cost of Project = $217,391

So, maximum amount paid for this project is $217,391

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