Question: Your boss is considering an investment in new manufacturing equipment. The equipment costs $270,000 and will provide annual after-tax inflows of $45,000 at the end of each of the next 7 years. The firm's market value debt/equity ratio is 25%, its cost of equity is 17%, and its pretax cost of debt is 9%. The firm's tax rate is 40%. Assume the project is of approximately the same risk as the firm's existing operations.
- What is the weighted average cost of capital? What is the NPV of the proposed project (Think about what is appropriate discount rate)?
- The company decides to increase its market value debt/equity ratio to 30%. Assume that the cost of equity and the cost of debt stay the same. What is the new weighted average cost of capital?
- What is the NPV after the capital structure change?