Question

A firm is considering a project that will generate perpetual cash flows of $50,000 per year beginning next year. The project has the same risk as the firm's overall operations. If the firm's WACC is 12%, and its debt-to-equity ratio is 1.33, what is the most it could pay for the project and still earn its required rate of return

Answer 1

Answer:

Present value = $416666.6667 rounded off to $416666.67

Explanation:

To calculate the most the firm could pay for the project, we will need to calculate the present value of the project when discounted at the WACC for the project, which is equal to the WACC for the firm in this case. The cashflows from the project will be perpetual, thus we will use the formula for the present value of perpetuity.

Present value of perpetuity = Cash flow / r

Where,

r is the rate of discount or discount factor which in this case is WACC

Present value = 50000 / 0.12

Present value = $416666.6667 rounded off to $416666.67