Wind, Inc. is considering a scale-expanding investment of $42 million. The inves

Question

Wind, Inc. is considering a scale-expanding investment of $42 million. The investment is expected to generate an EBITDA of $13.63 million per year for five years. The investment would be depreciated straight-line over that same time period. The company tax rate is 35 percent. The company has bonds outstanding with the total market value of $55 million and a yield to maturity of 6.5 percent. The company also has 4.5 million shares of common stock outstanding, which are selling at a share price of $25. The company’s CEO considers the firms current debt – equity ratio optimal. Easy-Breeze, LLC is a publicly traded all-equity competitor with a ß of .7892. The expected market risk premium is 7.5 percent. Treasury bills are currently priced at 3.4 percent. •use the weighted average cost of capital approach to determine Mighty Wind should make the investment. •suppose the company decides to fund this investment entirely with debt. Determine the appropriate cost of capital; explain.

Explanation / Answer

If the investment is going to be fully funded by debt, the appropriate discounting factor or COC, to discount the cash flows(inflows and outflows) will be the after tax cost of debt ,ie. 4.23%- because this is the cost given by the company to acquire that money.

After-tax cost of bonds=0.065*(1-0.35)= 0.04225 4.23% Cost of equity=Risk-free rate+Beta*(Market Risk Premium)

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