Nally, Inc. is considering a project that will result in intitial aftertax cash

Question

Nally, Inc. is considering a project that will result in intitial aftertax cash savings of $6.1 million at the end of the first year, and these savings will grow at a rate of 3% per year indefinetely. The firm has a target debt-equity ratio of .60, a cost of equity of 13% and a aftertax cost of debt of 5.5%. The cost-saving proposal is somewhat risky thatn the usual project the firm undertakes, management uses the subjective approach and applies an adjustment factor of +3% to the cost of capital for such risky projects. Requirement 1: Calculate the WACC. Requirement #2 What is the maximum cost Nally would be willing to pay for this project?

Explanation / Answer

requirement 1)

WACC=(0.60/1.60*3%)+(1/1.60*13%)=9.25%

requirement2

maximum cost of capital=9.25%+3%=12.25%

6,000,000/(12.25-3)= $648,649

WACC=(0.60/1.60*3%)+(1/1.60*13%)=9.25%

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