1. What is the appropriate discount rate to use when evaluating AAIs project (10 Points)

Aria Acoustics. Inc. (AAI). projects unit sales for a new seven-octave voice emulation implant as follows: Year Unit Sales 1 73,200 2 86.200 3 105,250 4 97,300 5 67,400 Production of the implants will require $1,550,000 in net working capital to start and additional net working capital investments each year equal to 10 percent of the projected sales increase for the following year. Total fixed costs are $3,300.000 per year, variable production costs are $256 per unit, and the units are priced at $378 each. The equipment needed to begin production has an installed cost of $16,700,000. 0 Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 15 1 percent of its acquisition cost. The tax rate is 21 percent. The following market data on AAI's securities are current: 2 Debt: 11,000 6 percent coupon bonds outstanding. S1.000 par value, 26 years to maturity, selling for 108 percent of par: the bonds make semiannual payments. 3 Common stock: 440,000 shares outstanding, selling for $62 per share; beta is 1.13. Preferred stock: 19,000 shares of 3.8 percent preferred stock outstanding, currently selling for $83 per share. The par value is $100 per share. Market: 7 percent of the market risk premium and 4.8 percent risk-free rate. 6 7