Speedy Delivery Systems can buy a piece of equipment that is anticipated to prov

Question

Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 11 percent return and can be financed at 8 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a 15 percent return but would cost 17 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm's capital structure. a. Compute the weighted average cost of capital. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Weighted average cost of capital b. Which project(s) should be accepted? New machine Piece of equipment

Explanation / Answer

given that

cost of debt = 8%

yield return = 15%

cost of equity = 17%

debt and common equity (or) weight of equity = 50% (or) 0.50

a) calculation of weighted average cost of capital :

weighted average cost of capital = (weight of quitey * cost of equity) + (weight of equity * cost of debt)

WACC = (0.50 * 17%) + (0.50 * 8%)

= 8.5 + 4

= 12.5 %

weighted average cost of capital = 12.5 %

b) decision regarding the acceptance of project :

In this case the return from the new machine equipment is more than the weighted average cost of capital

new machine yield return 15 % > weighted average cost of capital 12.5 %

therefore, It is better to accept the new machine because the yield return is 15 %

weighted average cost of capital = (weight of quitey * cost of equity) + (weight of equity * cost of debt)

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