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 $1.87 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debt-equity ratio of .75, a cost of equity of 12.7 percent, and an aftertax cost of debt of 5.5 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 2 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, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.) Maximum cost

Explanation / Answer

CFAT 1st year= $1.87 million

CFAT 2N=nd year= 1.87*1.01= $1.89 million

D/E= 0.75 , WD= 0.75/1.75=0.42857

WE= 1/1.75= 0.57143

Kc= 0.42857*5.5+0.57143*12.70= 9.6143%

Required return= 9.6143+2= 11.6143%

PV of expected cashflows

Using BAII plus calculator

Go to cashflow mode

C0= 0

C1= 1.87

C2= 1.89

I = 11.6143%

NPV CPT

PV of cashflows= $3.1925 millions

So the maximum Initial amount that company sholud be $ 3.1925 millions so that NPV will 0

NPV= PV of inflows- Initial outlay

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