Nally, Inc., is considering a project that will result in initial aftertax cash

Question

Nally, Inc., is considering a project that will result in initial aftertax cash savings of $6.5 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 .64, a cost of equity of 13.4 percent, and an aftertax cost of debt of 5.9 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?

Nally, Inc., is considering a project that will result in initial aftertax cash savings of $6.5 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 .64, a cost of equity of 13.4 percent, and an aftertax cost of debt of 5.9 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.

Explanation / Answer

Requirement 1:

  WACC :-

WACC = 17.176 / 1.64

= 10.47 %.

As 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, therfore, WACC is taken at 11.47% ( 10.47 + 1)

Conclusion:- WACC = 11.47%

Requirement 2:-

The maximum cost nally would be willing to pay for this project = $ 6.5 Milion / 0.1147 - 0.03

= $ 6.5 Milion / 0.0847

= $ 76.74 Milion (approx)

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