Question

Based on market values, Gubler's Gym has an equity multiplier of 1.45 times. Shareholders require a return of 10.87 percent on the company's stock and a pretax return of 4.83 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $275,000 per year for 6 years. The tax rate is 35 percent. What is the most the company would be willing to spend today on the project?

Answer 1

Solution:-

Here,Gubler's Gym Equity Multiplier has 1.45 time.That mean the company mostly funded by the share holders fund.

Equity Multiplier =Total Assets/Total Share Holders Equity.

That means ,in the above case the company has only 31% (.45/1.45*100)funded from Debts to the assets.Low equity multiplier implies that a company that is mostly depended on share holders fund and that the debt financing is low making is a fairly conservative investment .The flip side is that its growth prospects might not be too high given its low financial leverage.In the above case the company can make new project that the equity multiplier has low.