Feera Corporation is evaluating a new project that costs $45,000. The project wi

Question

Feera Corporation is evaluating a new project that costs $45,000. The project will be financed using 40% debt and 60% equity, thus maintaining the firm’s current debt-to-equity ratio. The firm’s stockholders have a required rate of return of 18.36%, and its bondholders expect a 10.68% rate of return. The project is expected to generate annual cash flows of $13,000 before taxes for the next two decades. Fiera Corporation is in the 36% tax bracket. Remember to show all your work.

1. Use the flow-to-equity (FTE) method to determine whether or not the project should be undertaken and explain why.

Explanation / Answer

ke=k+(1-t)(k-r)d

k= cost of capital with no leverage

t= the tax rate

r =rate of interest on the debt

d=market debt to equity ratio

=0.1836+(1-0.36)*(0.1836-0.1068)*(0.6666)=21.64 %

CS = 13000-.64*.1068*D =13000+.06835D

The expected incremental after tax cash flow

(13000/.2164)-(.1068/.2614*40/60)E=45201

D=+45201*.40 =18080

45000-18080=26920

NPA 45201-26920=18281

Since the project ahs positive NPV project has to undetaken

ke=k+(1-t)(k-r)d

k= cost of capital with no leverage

t= the tax rate

r =rate of interest on the debt

d=market debt to equity ratio

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