Bono, Inc., is considering a project that will result in initial aftertax cash s

Question

Bono, Inc., is considering a project that will result in initial aftertax cash savings of $5.1 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 .50, a cost of equity of 13 percent, and an aftertax cost of debt of 6.4 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 +2 percent to the cost of capital for such risky projects.

Under what circumstances should the company take on the project?

Explanation / Answer

Bono Inc should undertake the project only when the project is giving a positive NPV after disocutning the cash flow at the following rate of return WACC = 13%*0.5+6.4%*0.5 + 2% = 11.7% If the NPV is positive, then the project should be undertaken, otherwise not Happy to help

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