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 $6.8 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.

What is the maximum cost Nally would be willing to pay for this project?

The WACC is 10.4%.

Explanation / Answer

The company is willing to pay 1% extra for the riskier projects over the WACC. Current WACC is 10.40%

Maximum cost = 10.40% +1%

                                = 11.40%

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