Problem:
Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $1.81 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 12.1 percent, and an aftertax cost of debt of 4.9 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.
Required:
Question: What is the maximum initial cost the company would be willing to pay for the project?
Note: Show supporting computations in good form.