Inc. is considering a project that will result in initial aftertax cash savings
ID: 2345458 • Letter: I
Question
Inc. is considering a project that will result in initial aftertax cash savings of $4.1 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target debt-equity ratio of 0.56, a cost of equity of 15 percent, and an aftertax cost of debt of 4 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 +3.6 percent to the cost of capital for such risky projects.(a)
Calculate the WACC.
Weighted average cost of capital %
(b)
What is the maximum cost Inc. would be willing to pay for this project?
PV of future CF $
Explanation / Answer
a) wacc =0.56/1.56*4% + 1/1.56*15% =11.05% Maximum cost of capital =11.05%+3.6% =14.65% maximum cost Inc. would be willing to pay for this project =4.1/(14.65%-4%) = $38.498