Question
National Electric Company (NEC) is considering making a $20 million modernization expansion project in the power-systems division. Tom Edison, the companys chief financial officer, has
National Electric Company (NEC) is considering making a $20 million modernization expansion project in the power-systems division. Tom Edison, the companys chief financial officer, has evaluated the project; he determined that the projects EBIT will be $12.12 million in perpetuity. NECs cost of debt is 10 percent, and its cost of equity is 20 percent. The firms target debt-equity ratio is 200 percent. The expansion project has the same risk as the existing business, and it will support the same amount of debt. NEC is in the 34 percent tax bracket. Assume that annual depreciation charges for the project will exactly equal annual capital expenditure charges necessary to maintain the project. Using WACC analysis, should NEC accept the project?
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