Scanlin, Inc., is considering a project that will result in initial aftertax cas

Question

Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $5.1 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target debt-equity ratio of 0.63, a cost of equity of 14 percent, and an aftertax cost of debt of 6 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of 2.1 percent to the cost of capital for such risky projects.
(Do not include the dollar sign ($). Do not round your intermediate calculations. Round your answer to the nearest whole number. (e.g., 32))

The project should only be taken if its cost is less than $_______

Explanation / Answer

D/E = 0.63 --> D = 0.63E
Total value, V= D+E = 1.63E
E = V/1.63 = 0.613V, E/V=0.613
D/V=1-E/V = 0.387
WACC = 0.613*14%+0.387*6% = 10.9%

WACC_adjusted = 10.9%+2.1% = 13%
NPV of project cash flow = 5.1/(r-g) = 5.1/(0.13-0.04) = $56.67 million

The project should only be taken if its cost is less than $56.67 million

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