Scanlin, Inc., is considering a project that will result in initial aftertax cas

Question

Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $1.77 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debtequity ratio of .75, a cost of equity of 11.7 percent, and an aftertax cost of debt of 4.5 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.

What is the maximum initial cost the company would be willing to pay for the project?

Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $1.77 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debtequity ratio of .75, a cost of equity of 11.7 percent, and an aftertax cost of debt of 4.5 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.

Explanation / Answer

Maximum initial cost:

= $1.77 million÷(10.61%-1%)

= $18.42 million

WACC = Wd×Rd×(1-t)+We×Ke W is weights of respective portfolios R is return on respective portfolios Cost of equity 11.70% After tax cost of debt 4.50% Equity weight                                     0.57 Debt weight                                     0.43 WACC 8.61% Add: Adjustment factor 2.00% Relevant discount rate for project 10.61%

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.