Problem:
WACC and NPV. Sallinger, Inc., is considering a project that will result in initial aftertax cash savings of $6 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target debt-equity ratio of .7, a cost of equity of 16 percent, and an aftertax cost of debt of 7 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. Under what circumstances should Sallinger take on the project?