Question

Based on market values, Gubler's Gym has an equity multiplier of 1.53 times. Shareholders require a return of 11.19 percent on the company's stock and a pretax return of 4.91 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $291,000 per year for 6 years. The tax rate is 40 percent. What is the most the company would be willing to spend today on the project?

Answer 1

Before tax cost of debt 4.91% after tax cost of debt = 2.95% [ 4.91% 0.6] After tax WACC: Particulars Debt common stock weight 35% 65% cost 2.95% 11.19% weighted cost 0.0102 0.0731 - 8.33% WACC Appropriate discount rate = WACC = 8.33% Year cash flows $291,000 $291,000 $291,000 $291,000 $291,000 $291,000 pv @ 8.33% 0.92307 0.85206 0.78651 0.72600 0.67015 0.61859 Willing to spend present value $268,613.15 $247,948.53 $228,873.66 $211,266.24 $195,013.37 $180,010.84 $1,331,726