Question

3. Road Runner Corporation is considering an expansion of its manufacturing plant.  The project would cost $30 million in initial investment but it’s expected to result in after tax cash flows to the firm of $3.5 million per year for the next 14 years.  You have the following information about the firm’s capital structure and market conditions:  

Common stock:           2 million shares outstanding

                                    Current market price is $35 per share

                                    Par value is $1 per share

                                    Beta = 1.2

Bonds:                         90,000 bonds outstanding

                                    8% coupon paid semi-annually

                                    8 years to maturity

                                    Selling at 112% of face value

Market conditions       The average market return is 12%

                                    Risk free rate is 4%

                                    Tax rate is 32%

1. What is the firm’s weighted average cost of capital?  

2. Using NPV principles, should the firm proceed with this expansion?

Answer 1

a)

b)