Please answer all parts of the question. Nally. Inc., is considering a project t
ID: 2719529 • Letter: P
Question
Please answer all parts of the question.
Nally. Inc., is considering a project that will result in initial aftertax cash savings of $6.8 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt-equity ratio of .67. a cost of equity of 13.2 percent, and an aftertax cost of debt of 6.2 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 +1 percent to the cost of capital for such risky projects. Calculate the WACC. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) What is the maximum cost Nally would be willing to pay for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)Explanation / Answer
Requirement 1)
Cost of capital = Weight of Equity* Cost of Equity + Weight of Debt* After Tax cost of Debt
Cost of capital = 1/(1+0.67) * 13.2 + 0.67/(1+0.67) *6.2
Cost of capital = 10.40%
Risk Adjusted Cost of capital= Cost of capital + Additional Risk premium
Risk Adjusted Cost of capital = 10.40% + 1%
Risk Adjusted Cost of capital = 11.40%
Answer
WACC for project = 11.40%
Requirement 2
Maximum initial cost the company would be willing to pay for the project = aftertax cash savings/(Risk Adjusted Cost of capital - growth rate)
Maximum initial cost the company would be willing to pay for the project = 6800000/(11.40%-3%)
Maximum initial cost the company would be willing to pay for the project = $ 80,952,380.95
Answer
Present Value = $ 80,952,380.95
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