Nally, Inc., is considering a project that will result in initial aftertax cash
ID: 2766542 • 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.
What is the maximum cost Nally would be willing to pay for this project?
Explanation / Answer
Solution :
WACC = Kd * Wd + Ke*We
(0.068*0.67)+(0.132*.33)
8.912%
Kd = cost of debt
Ke= cost of equity
Wd/We = debt/equity weight
Risk adjusted cost of capital
(8.912%+1%)
9.912%
Present value of cashflow till infinity = cash savings/(cost of capital-growth)
98,379,629.63
6800000/(0.0912-0.03)
hence maximum cost Nally would be willing to pay for this project
98,379,629.63
WACC = Kd * Wd + Ke*We
(0.068*0.67)+(0.132*.33)
8.912%
Kd = cost of debt
Ke= cost of equity
Wd/We = debt/equity weight
Risk adjusted cost of capital
(8.912%+1%)
9.912%
Present value of cashflow till infinity = cash savings/(cost of capital-growth)
98,379,629.63
6800000/(0.0912-0.03)
hence maximum cost Nally would be willing to pay for this project
98,379,629.63
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