All problems are available in MyFinanceLab. P9-1 Concept of cost of capital Mace
ID: 2614449 • Letter: A
Question
All problems are available in MyFinanceLab. P9-1 Concept of cost of capital Mace Manufacturing is in the process of anal ojects evaluated by the firm recent The basic involved building new facilties in different regions, North and South. The tly variables surrounding each project analysis and the resulting decision summarized in the following table. investment decision-making procedures. Two projects evaluated by South. cisio actions are Basic variables Cost Life Expected return Least-cost financing North $6 million 15 years 8% South $5 milliorn 15 years 15% Debt 7% Source Equity 16% Cost (after-tax) Decision Action Reason Invest Don't invest 890 > 7% cost 15%Explanation / Answer
a. Since the Expected return is more than the cost of capital (.8>.7) , analyst would recommend to pursue the project
b. Since the Expected return is less than the cost of capital(.15<.16) , analyst would recommend to abandon the project.
c. Wealth maximization of the investors is the obective of the organization. Wealth maximization is achieved when an organization earns more than its WACC . In this case since the project with lower return is selected , it would push down the market value of investment.
d.
e.
f. The initial decision is made without taking into account the WACC of the company as a whole. Financing is done from the perspective of the company rather than on the basis of individual project. Any investment decision disregarding the WACC of the company may impact the total value of the investment of shareholders since it would lead to selection of project with lesser return.
Debt Equity Total Cost of Capital 7.00% 16.00% Weight 40.00% 60.00% WACC 2.80% 9.60% 12.40%