Question

Based on market values, Gubler's Gym has an equity multiplier of 1.45 times. Shareholders require a return of 10.87 percent on the company's stock and a pretax return of 4.83 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $275,000 per year for 6 years. The tax rate is 35 percent. What is the most the company would be willing to spend today on the project

Answer 1

Answer:

The most the company would be willing to spend today on the project is

$1,253,529

Explanation:

In order to calculate What is the most the company would be willing to spend today on the project we woule require to calculate first the cost of capital as follows:

cost of capital=(1-1/1.45)*4.83%*(1-35%)+(1/1.45)*10.87%

cost of capital=0.01498*0.65+0.0749=0.084637=8.4637%

Therefore, Maximum amount to be spent=$275,000/8.4637%*(1-1/(1+8.4637%)^6)=$1,504,124.98

Maximum amount to be spent=$1,253,529

The most the company would be willing to spend today on the project is

$1,253,529