Carson Electronics uses 70 percent common stock and 30 percent debt to finance i

Question

Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and the cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project? Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 5.4 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

Explanation / Answer

a) WACC = (0.70)(0.154) + (0.30)(0.054) = 0.124

PV = $36,000 ( 0.124 - 0.03 ) = $ 382,979

b)

WACC = 0.08 = [ We 0.152 ] + [1-We][0.054]

==> We = 0.265

Wd = 1- We = 1-0.265 = 0.735

Debt equity ratio = Wd/We = 0.735/0.265 = 2.77

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.