Question

Problem 12-21 WACC and NPV [LO 4]

Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $5.5 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 debt–equity ratio of .54, a cost of equity of 13.4 percent, and an aftertax cost of debt of 6.8 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 +3 percent to the cost of capital for such risky projects.

Calculate the WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
WACC             %

What is the maximum cost the company would be willing to pay for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
  
Present value            $

Answer 1

Particulars Equity Debt weight 0.649 0.351 cost 13.40% 6.80% weighted cost 0.087 0.024 11.09% WACC Cost of capital = WACC + 3%(adjustment factor) WACC to be used for project 14.09% [ 11.09% + 3%] Maximum initial cost = $49,613,402.06 5500000/(0.1409-0.03)