Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $204,000, be useful for four years, and have a $15,000 salvage value.
Tate expects annual savings in cash operating expenses (before taxes) of $71,000. For tax purposes, the annual depreciation deduction will be $68,000, $91,400, $29,700, and $14,900, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%.
Tate establishes a cutoff rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point.
Tate's capital is provided in the following proportions: debt, 60%; common stock, 20%; and retained earnings, 20%. The cost rates for these capital sources are debt, 10%; common stock, 12%; and retained earnings, 13%.
a. Compute Tate's (1) weighted average cost of capital and (2) cutoff rate. Round answers to one decimal place. For example, 0.4567 = 45.7%.