Glenlivet Company is considering a new four-year project that complements its existing business. This project requires an initial fixed asset investment of $4,000,000. The fixed asset will be depreciated straight-line to zero over its four-year tax life, after which it will be worthless. The project is estimated to generate $2,800,000 in annual sales, with costs of $1,100,000. The company is an all-equity financed company and its cost of capital is 10%. The tax rate is 35%.
a Evaluate whether Glenlivet Company should accept this new project.
b If the new project's beta risk is not equal to that of the company, evaluate whether Glenlivet Company should accept the new project.
Assume the beta risk of the new project is 1.5, the expected risk premium on the market is 10%, and risk free bonds are yielding 5%.
c Discuss two consequences if Glenlivet Company always uses the weighted average cost of capital (WACC) to make decisions for all new projects.