Question
Bob's is a retail chain of specialty hardware stores. The firm has 18,000 shares of stock outstanding that are currently valued at $82 a share
Bob's is a retail chain of specialty hardware stores. The firm has 18,000 shares of stock outstanding that are currently valued at $82 a share and provide a rate of return of 13.2 percent. The firm also has 600 bonds outstanding that have a face value of $1,000, a market price of $1,032, and a coupon rate of 7 percent. These bonds mature in 7 years and pay interest semiannually. The tax rate is 35%. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $9.3 million and is expected to produce cash inflows of $1.07 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis to a zero book value over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for an after-tax value of $4.7 million. Should the firm accept or reject the superstore project and why? a. What is the firms WACC? b. Suppose that the company uses the following subjective approach to adjust the companys WACC for individual projects: high risk +4%, moderate risk +0% (i.e. same as WACC), low risk -4%. Considering the nature of the new project what adjustment would you recommend? Briefly explain. (there is no partial credit if the explanation is missing)
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