All problems d\'e dv P9-1 Concept of cost of capital Mace Manufacturing is in th
ID: 2614447 • Letter: A
Question
All problems d'e dv P9-1 Concept of cost of capital Mace Manufacturing is in the pr investment decision-making procedures. Two projects evaluat involved building new facilities in different regions, North and Sourh r variables surrounding each project analysis and the resulting decision actio rocess of analyzing t by the firm recer The basic summarized in the following table. Basic variables Cost Life Expected return Least-cost financing North $6 million 15 years 0% South $5 million 15 years 15% Debt 796 Equity 16% Source Cost (after-tax) Decision Action Reason Invest Don't invest 15% 7% costExplanation / Answer
a. Investing of North by debt funds will cost to 7% and the returns are 8 % which is more than the cost of the debt i.e. North facility is providing net return of 1% which will added to the wealth of the share holders hence it is suggested to invest in north facility by debt funds.
b. Investing of South facility by using retaining earning will increase the expectations of share holders. which cost to business is 16%. However the returns from the south faciliity is 15%. which is less than the expected returns of the share holders. Hence south facility is not viable to the business.
c. North facility is in the interests of investors because which is contributing to the wealth of the investors. but in case of south facility expected returns are less than the cost of the funds. hence it is not in the interest of the investors
d. Weighted average cost = (0.4 X 7%) + (0.6 X 16%)
=12.4%
e. If weighted average cost is considered then south facility is viable where cost is than the expected returns and contributes wealth of the investors. on other hand, north facility cost is more than expected returns which is not in the interest of the investors.
f. Instead of using one source of funds, having leveraged funds will contribute more to the business. In the case of "a and b", north facility will be invested and will contributed only 1% to the investors. but in case of "e" south facility will be selected and which will provide the 2.6% (15%-12.4%) of investment additionally. Hence weighted average cost approach by using two sources funds will contribute to the investors.