Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Concept of cost of capital Mace Manufacturing is in the process of analyzing its investment decision-making procedures. Two projects evaluated by the firm recently involved
Concept of cost of capital Mace Manufacturing is in the process of analyzing its |
investment decision-making procedures. Two projects evaluated by the firm recently |
involved building new facilities in different regions, North and South. The basic |
variables surrounding each project analysis and the resulting decision actions are |
summarized in the following table. |
Basic variables North South |
Cost $6 million $5 million |
Life 15 years 15 years |
Expected return 8% 15% |
Least-cost financing |
Source Debt Equity |
Cost (after-tax) 7% 16% |
Decision |
Action Invest Dont invest |
Reason 8% > 7% cost 15% <16% cost |
a. An analyst evaluting the North facility expects that the project will be financed |
by debt that costs the firm 7%. What recommendation do you think this analyst |
will make regarding the investment opportunity? |
b. Another analyst assigned to study the South facility believes that funding for that |
project will come from the firms retained earnings at a cost of 16%. What recommendation |
do you expect this analyst to make regarding the investment? |
c. Explain why the decisions in parts a and b may not be in the best interests of the |
firms investors. |
d. If the firm maintains a capital structure containing 40% debt and 60% equity, |
find its weighted average cost using the data in the table. |
e. If both analysts had used the weighted average cost calculated in part d, what recommendations |
would they have made regarding the North and South facilities? |
f. Compare and contrast the analysts initial recommendations with your findings |
in part e. Which decision method seems more appropriate? Explain why. |
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started