Question

Sallinger, Inc. is considering a project that will result in initial after-tax cash savings of $6...

Sallinger, Inc. is considering a project that will result in initial after-tax cash savings of $6 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 debt-equity ratio of 0.75, a cost of equity of 16 percent, and an after-tax cost of debt of 7 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. Under what circumstances should Sallinger take on the project?

Homework Answers

Answer #1

Answer : Circumstances in which the project should be undertaken by Sallinger :-->

Given the Debt - Equity ratio = 0.75 :1

Therefore

Weight of Equity = 1 / (1+0.75)

     = 1 / 1.75

   = 0.57143

Weight of Debt = 1 - 0.57143

= 0.42857

WACC = (Cost of Equity * Weight of Equity) + (After tax Cost of Debt * Weight of Debt)

= (16% * 0.57143) + (7 % * 0.42857)

= 9.14288 + 2.99999

= 12.14287 % or 12.143 %

Cost of Project = 12.143% + 2

= 14.143 % or 0.14143

Present value of Future cash flows = After tax cash savings / (Cost of Project - Growth rate )

= 6 million / ( 0.14143 - 0.01)

= $ 6 million / 0.13143

= $ 45.652 million

NPV = -cost + PV of future cashflows

0 = - cost + 45.652

cost = $ 45.652

Therefore The project should be undertaken if the cost is less than $45.652 million.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.89...
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.89 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The firm has a target debt–equity ratio of .8, a cost of equity of 12.9 percent, and an aftertax cost of debt of 5.7 percent. The cost-saving proposal is somewhat riskier than the usual projects the firm undertakes; management uses the subjective...
Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $6...
Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $6 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt-equity ratio of .59, a cost of equity of 13.4 percent, and an aftertax cost of debt of 5.3 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective...
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.79...
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.79 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The company has a target debt–equity ratio of .85, a cost of equity of 11.9 percent, and an aftertax cost of debt of 4.7 percent. The cost-saving proposal is somewhat riskier than the usual projects the firm undertakes; management uses the subjective...
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.72...
Och, Inc., is considering a project that will result in initial aftertax cash savings of $1.72 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The company has a target debt–equity ratio of .8, a cost of equity of 11.2 percent, and an aftertax cost of debt of 4 percent. The cost-saving proposal is somewhat riskier than the usual projects the firm undertakes; management uses the subjective...
Problem 14-20 WACC and NPV [LO3, 5] Sommer, Inc., is considering a project that will result...
Problem 14-20 WACC and NPV [LO3, 5] Sommer, Inc., is considering a project that will result in initial aftertax cash savings of $1.86 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The firm has a target debt-equity ratio of .80, a cost of equity of 12.6 percent, and an aftertax cost of debt of 5.4 percent. The cost-saving proposal is somewhat riskier than the usual project...
Super corp. is considering a project that will result in initial after tax cash saving of...
Super corp. is considering a project that will result in initial after tax cash saving of $2.7 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. Super corp. has a target debt-equity ratio of 0.9, a cost of equity of 13%, and an after tax cost of debt of 4.8%. As the project is considered to be riskier than the firm’s existing projects, the management uses the...
Hero Manufacturing is considering to make an investment to develop a new plane that will result...
Hero Manufacturing is considering to make an investment to develop a new plane that will result in initial aftertax cash savings of $1.74 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The company has a target debt-equity ratio of .75, a cost of equity of 11.4 percent, and an aftertax cost of debt of 4.2 percent. The cost-saving proposal is somewhat riskier than the usual projects...
Antonio's is analyzing a project with an initial cost of $31,000 and cash inflows of $27,000...
Antonio's is analyzing a project with an initial cost of $31,000 and cash inflows of $27,000 a year for 2 years. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance their operations and maintains a debt-equity ratio of 0.5. The pre-tax cost of debt is 9.6 percent and the cost of equity is 12.3 percent. The tax rate is...
4, A proposed project lasts three years and has an initial investment of $200,000. The after-tax...
4, A proposed project lasts three years and has an initial investment of $200,000. The after-tax cash flows are estimated at $82,120 for year 1, $163,560 for year 2, and $179,200 for year 3. The firm has a target debt/equity ratio of 1.35. The firm's cost of equity is 16.18% and its cost of debt is 11.38%. The tax rate is 34%. What is the NPV of this project?
Panelli's is analyzing a project with an initial cost of $110,000 and cash inflows of $65,000...
Panelli's is analyzing a project with an initial cost of $110,000 and cash inflows of $65,000 in year 1 and $74,000 in year 2. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of .45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the...