Company DEF needs advice regarding its investment decisions. Investment alternative A which the company is currently evaluating is a new machine with an initial outlay of $2,000,000, economic life of 4 years and no residual value. The machine will be related to an incremental annual revenue of $1,000,000 and incremental annual costs of $320,000. The machine will be depreciated on a straight-line basis.

Some time ago, DEF has issued bonds with total face value of $18,000,000 which pay annual coupons of 7.5% and have a maturity date in 9 years. The yield on comparable bonds in the market is 6%. DEF has a total of 4,200,000 outstanding shares with a current price of $4.21 each. The average return on the equity market index is 8.9% while the yield on government bonds is 3.2%. The companys beta is 1.44. Furthermore, the company has 1,500,000 preference shares with a face value of $1, a coupon rate of 8% and current market price of $0.85 each. The companys tax rate is 20%.

A. Calculate the companys after-tax WACC.

B. Evaluate investment project A using the NPV and IRR methods of capital budgeting and provide an investment decision according to each of these criteria. Use the approximation method for calculating the IRR.

C. DEF is considering as a second alternative the project B with an initial outlay of $1,500,000 and incremental after-tax cash flows of $560,000, $460,000, $400,000, $320,000 and $300,000 for years 1 to 5, respectively. Project A and Project B are mutually exclusive. Which project should be chosen based on the constant chain of replacement assumption? Hint: Calculate the equivalent annual annuity (EAA).