Company is considering a $97 million project in its power
systems division. The company's chief financial officer, has
evaluated the project and determined that the project's unlevered
cash flows will be $3.76 million per year in perpetuity. The
company's chief financial officer has devised two possibilities for
raising the initial investment: Issuing 10-year bonds or issuing
common stock. The company's pretax cost of debt is 8.2 percent, and
its cost of equity is 13.5 percent. The company's target
debt-to-value ratio is 65 percent. The project has the same risk as
the company's existing businesses, and it will support the same
amount of debt. The tax rate is 23 percent. Should Company accept
the project?
Shows all the step and formula. Don't round off until you get the
answer.
The project should be accepted if the return from project is higher than the weighted average cost of capital
Return from project = annual cash flows/Investment
= 3.76 million/97 million
= 3.8763%
Weighted average cost of capital = cost of debt*weight of debt + cost of equity*weight of equity
= 8.2%(1-23%)*65% + 13.5%*35%
= 8.8291%
Since the cost is higher than return, the project should not be accepted
Company is considering a $97 million project in its power systems division. The company's chief financial...
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