Question

Weighted Average Cost of Capital and Net Present Value Analysis
Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $192,000, be useful for four years, and have a $12,000 salvage value. Tate expects annual savings in cash operating expenses (before taxes) of $68,000. For tax purposes, the annual depreciation deduction will be $64,000, $86,000, $28,000, and $14,000, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%.
Tate establishes a hurdle rate for a net present value analysis at the company’s weighted average cost of capital plus 1 percentage point. Tate’s capital is provided in the following proportions: debt, 60%; common stock, 20%; and retained earnings, 20%. The cost rates for these capital sources are debt, 10%; common stock, 12%; and retained earnings, 13%.

a. Compute Tate’s (1) weighted average cost of capital and (2) hurdle rate.
Round answers to one decimal place. For example, 0.4567 = 45.7%.

	Weighted Average Cost of Capital
Debt	Answer
Common stock	Answer
Retained earnings	Answer
(1) Weighted avg. cost of capital	Answer
(2) Tate's hurdle rate:	Answer

b. Using Tate’s hurdle rate, compute the net present value of this capital expenditure proposal.
Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers.

After-Tax Cash Flow Analysis
	Amount	Present Value
After-tax cash expense savings	Answer	Answer
Tax savings from depreciation
Year 1	Answer	Answer
Year 2	Answer	Answer
Year 3	Answer	Answer
Year 4	Answer	Answer
After-tax equipment sale proceeds	Answer	Answer
Total present value of future cash flows		Answer
Investment required in equipment		Answer
Net positive (negative) present value		Answer

Under the net present value analysis, should Tate accept the proposal?

Select the most appropriate answer below.

Tate should not accept the proposal, because its net present value is positive.

Tate should accept the proposal, because its net present value is negative.

Tate should accept the proposal, because its net present value is positive.

Tate should not accept the proposal, because its net present value is negative.

Answer 1

Under the net present value analysis, should Tate accept the proposal?

Select the most appropriate answer below.

Tate should not accept the proposal, because its net present value is negative