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 $1.86 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The firm has a target debt–equity ratio of 0.80, a cost of equity of 12.6 percent, and an aftertax cost of debt of 5.4 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 3 percent to the cost of capital for such risky projects.

What is the maximum initial cost the company would be willing to pay for the project? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)

PLEASE PROVIDE FINAL AND CORRECT ANSWER.

Explanation / Answer

cash flow now=$1.86mn

debt to equity=0.8
debt to assets=D/E/(1+D/E)
=0.8/1.8=0.4444
equity to assets= 1- Debt to assets
=1-0.4444=0.5556

after tax Cost of debt=5.4%
cost of equity=12.6%

WACC=(wt of debt* cost of debt)+(wt of equity*cost of equity)
=(.4444*5.4%)+(0.5556*12.6%)=9.4%

Project discount rate=9.4%+3%=12.4. since it is given risky so 3% more

growth=2%
Present value= 1.8mn/(k-g)
k= WACC ang g=2%
present value=$25,134,048

This is maximum initial cost the company can afford

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

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