Question

a,b,c,d,f?

Concept of cost of capital Mace Manufacturing is in the process of analyzing its investment decision-making procedures. Two projects evaluated by the firm recently involved building new facilities in different regions, North and South. The basic variables surrounding each project analysis and the resulting decision actions are summarized in the following table: a. An analyst evaluating the North facility expects that the project will be financed by debt that costs the firm 5.3% What recommendation do you think this analyst will make regarding the investment opportunity? b. Another analyst assigned to study the South facility believes that funding for that project will come from the firm's retained earnings at a cost of 18.6% What recommendation do you expect this analyst to make regarding the investment? c. Explain why the decisions in parts a and b may not be in the best interest of the firm's investors. d. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table e. if both analysts had used the weighted average cost calculated in part d, what recommendations would they have made regarding the North and South facilities? 1. Compare and contrast the analysts' initial recommendations with your findings in parte. Which decision method seems more appropriate? Explain why. a. An analyst evaluating the North facility expects that the project will be financed by debt that costs the firm 5.3%. What recommendation do you think this analyst will make regarding the investment opportunity? (Select the best answer below) OA The analyst will probably recommend investing in the North project because the project's expected return of 5.3% is greater than the expected financing cost of 70% using the ather tax cost of debt OB. The analyst will probably recommend not investing in the North project because the project's expected return of 70% is greater than the expected financing cost of 5,3% using the after-tax cost of debt OC. The analyst will probably recommend investing in the North project because the project's expected return of 70% is greater than the expected financing cost of 5.3% using the after tax cost of debt OD. The analyst will probably recommend investing in the North project because the project's expected return of 5,3% is greater than the expected financing cost of 70% using the after-tax cost of debt

and e

Answer 1

d) WACC = 40%*5.3% + 60%*18.6% =13.28% (assuming no tax)

e) if both analysts had used WACC (weighted average cost of capital) for their analysis, the South project would be selected and North project would be rejected as the South project's return is greater than Weighted average cost whereas North project's return is less than WACC

f) The Initial recommendations of rejecting both projects were wrong as the company would benefit from the South Project 's higher rate of return

Using WACC to evaluate a project is better (if the project is of similar risk) as the firm incurs a cost equal to the WACC according to its capital structure and therefore , is the right choice