Retniw Inc. is evaluating a new project that will cost $30 million. This project

Question

Retniw Inc. is evaluating a new project that will cost $30 million. This project will result in estimated before-tax cost savings of $6 million at the enf of the first year, and these savings are expected to grow at a rate of 2% per year indefinitely. The first would like to keep its debt-equty ratio at 0.8. Its cost of equity is 18% and its before-tax cost of debt is 10%. Retniw's marginal tax rate is 40%.

a) what are the target weights on debt and equity for Retniw Inc?

b) what is the weighted cost of capital for Retniw Inc.

c)Using the weighted cost of capital for Retniw Inc., calculate the Net present value of this project.

d) should Retniw Inc invest in this new project ? why or why not?

Explanation / Answer

Cost $                                 30,000,000 Savings $                                       600,000 savings growth 2% D/E 0.8 Equity rate 18% Before tax cost of debt 10% Tax 40% Cost of debt 6% D/(D+E) 44% a. Target weights Debt $                                 13,333,333 Equity $                                 16,666,667 b. WACC 12.67% c. Present value of saving for perpetuity =(600000)/(WACC-g) $                                   5,625,000 d. Retwin should not invest because cost saving do not logically answer the investment

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