1.Scanlin, Inc., is considering a project that will result in initial aftertax c
ID: 2965885 • Letter: 1
Question
1.Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $1.70 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 debtequity ratio of 0.85, a cost of equity of 11.0 percent, and an aftertax cost of debt of 3.8 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?
2.
Stock Y has a beta of 1.0 and an expected return of 12.4 percent. Stock Z has a beta of 0.6 and an expected return of 8.2 percent.
What would the risk-free rate have to be for the two stocks to be correctly priced?
3.
Fama
What is the maximum initial cost the company would be willing to pay for the project?
2.
Stock Y has a beta of 1.0 and an expected return of 12.4 percent. Stock Z has a beta of 0.6 and an expected return of 8.2 percent.
What would the risk-free rate have to be for the two stocks to be correctly priced?
3.
Fama
Explanation / Answer
Target D/E of 0.85 means weight debt = 0.3333, weight equity = 0.6667
if you really mean cost of equity is 11%...
WACC = 0.3333(0.038) + 0.6667(0.11) = 0.086..now add the risk premium of 0.02 = 0.086 is the discount rate for the project, aka adjusted WACC...(g=growth rate)
Value = OpFreeCashFlow@t=1 / (adjustedWACC - g)
OFCF1 = OFCF(1+g) = $1.7mil(1.05) = 1,785,000
Value= 1,785,000 / (0.086 -0.03) = $31,875,000<max T.N. should be willing to pay
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