Nally, Inc., is considering a project that will result in initial aftertax cash
ID: 2753852 • Letter: N
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).)
Requirement 1:Calculate the WACC. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Explanation / Answer
1.
Computation of WACC
Debt equity ratio=.67
which indicates debt is equal to 67% of sharholders fund, so we can assume that shareholders fund= 1000 and debt fund = 670
By taking this assumtion we can calculate WACC
Weighted avg cost of capital will be= 10.38% rounted off to 10.40%
2.
Now add the risk premium of 0.01 = 11.40%is the discount rate for the project, aka adjusted WACC...(g=growth rate)
Value = Operating Free Cash Flow@t=1 / (adjusted WACC - g)
OFCF1 = OFCF(1+g) = $6.8mil(1.03) = 7,004,000
Value= 7,004,000 / (0.1140 -0.01) = $67346153.84
Thou value will be <max cost, therefor the company should be willing to pay for the project.
SORCE AMOUNT WEIGHT COST OF CAPITAL KO EQUITY 1000 .5988 13.%2 7.90 DEBT 670 .4012 6.2% 2.48 1670 1.00 10.38%Related Questions
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