Question
DairyCream Inc. is reviewing its capital budgeting proposals. The firms corporate tax rate is 25%, and its target capital structure is 60% debt and 40%
DairyCream Inc. is reviewing its capital budgeting proposals. The firms corporate tax rate is 25%, and its target capital structure is 60% debt and 40% equity. Given this information, answer the following questions:
1. Calculate the firms after-tax cost of debt, if the firm is looking to sell 20-year bonds for $950 each, if the bonds will carry an annual coupon of 8.5%, par value of $1,000, and flotation costs of $10 per bond.
2. The firms annual cost of retained earnings is 12%. Its after-tax cost of debt is equal to your answer in part (1). Given these costs of capital and the firms target capital structure describe above, what is the firms weighted average cost of capital?
3. The company is considering investing in a new conveyor system. The conveyor would cost $1,000,000 fully installed and will generate cash inflows of $165,000 per year for 10 years thereafter. Given these projected cash flows and the firms cost of capital found above, should the company finance the project? Explain why the firm should or should not finance the project.
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