Problem:
Och, 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 .8, 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 projects the firm undertakes; management uses the subjective approach and applies an adjustment factor of +3 per cent to the cost of capital for such risky projects.
Required:
Question: What is the maximum initial cost of company would be willing to pay for the project?
Note: Please provide reasons to support your answer.