Question

Intro Your company is evaluating two projects and has collected the following information: Expected return (IRR) Project A 12% Same as existing business Project B 7% Same as existing business Risk Equity Long-term debt Suggested source of financing After-tax cost of financing 17% 5% The company currently has a capital structure consisting of 50% equity and 50% long-term debt. 18 Attempt 1/5 for 10 pts. Part 1 Without doing any calculations, what should the company do and why? Look for a better reason to make a decision O Reject both projects, since their expected returns are too low Accept only project B, since its cost of financing is less than project A's O Accept only project A, since its expected return is greater than project B's Accept both projects, since they are not riskier than the existing business Accept only project B, since its expected return is greater than its cost of financing Submit Attempt 1/10 for 10 pts. Part 2 IB* What is the firm's overall (after-tax) cost of capital? 3+ decimals Submit Part 3 18 - Attempt 1/5 for 10 pts. Based on the previous answers, what should the firm do? O Something else Accept project A and reject project B Accept both projects Accept project B and reject project A Reject both projects Submit

Answer 1

HI

For part A)

for project A, IRR(12%) is lower than cost of financing (17%)

For project B, IRR is higher than cost of financing.

Hence Project B should be selected.since its expected return is higher than cost of capital.

part B)

after tax Cost of capital =debt/Value*cost of debt + equity/value*cost of equity

= 1/2*5% + 1/2*17%

= 2.5 + 8.5 = 11%

part C)

Based on cost of capital, firm should accept project A and reject project B.

Thanks