Nally, Inc., is considering a project that will result in initial aftertax cash savings of $6.2 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 .61, a cost of equity of 13.1 percent, and an aftertax cost of debt of 5.6 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 +1 percent to the cost of capital for such risky projects. Requirement 1: Calculate the WACC. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) WACC % Requirement 2: What is the maximum cost Nally would be willing to pay for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Present value $
Target D/E of 0.61
means weight debt =0.38
, weight equity = 0.62
Requirement 1: Calculate the WACC.
cost of equity is 13.1%…
and after tax coast of debt is 5.6%
Now we will calculate
WACC = 0.38(0.056) + 0.62(0.131)
= 0.102584
WACC = 10.2584%
Requirement 2:
What is the maximum cost Nally would be willing to pay for this project
now add the risk premium of 0.01 = 0.112584is the discount rate for the project, aka adjusted WACC…(g=growth rate)
Value = OpFreeCashFlow@t =1 / (adjustedWACC – g)
OFCF1 = OFCF(1+g) = $6.2mil(1.03)
= 6,386,000
Value= 6,386,000 / (0.112584 -0.03)
= $77,327,467<max Nally. should be willing to pay
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