Problem
Ariana, Incorporated, is considering a project that will result in initial aftertax cash savings of $6.9 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 .68, a cost of equity of 13.3 percent, and an aftertax cost of debt of 6.3 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.
a) Calculate the required return for the project.
b) What is the maximum cost the company would be willing to pay for this project?