Nally, Inc., is considering a project that will result in initial aftertax cash
ID: 2734126 • Letter: N
Question
Nally, Inc., is considering a project that will result in initial aftertax cash savings of $4.2 million at the end of the first year, and these savings will grow at a rate of 2.5 percent per year indefinitely. The firm has a target debt-equity ratio of .25, a cost of equity of 13.1 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. 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 $_______Explanation / Answer
Value of the project = Cash flows / Ke-G
Cash flows = 4200000
G = 2.5%
WACC = After tax cost of debt * Weight of debt + Cost of equity * Weight of equity
= 6.4*0.25+13.10*0.75 i.e 11.425%
Adjustment factor = 2%
Value = 4200000/11.425%+2%-2.5%
= 4200000/10.925% i.e 38443935.93
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