The Water company Plc needs to upgrade the water purification system. the company is looking at two possible systems : the first, the minor, will cost $120,000 per installation and will have an operating cost of $11,000 annually; the other system, the major will cost $225,000 per installation and has an annual operating cost of $ 6,000 per installation. Both systems will be depreciated straight line to zero over their working lives. The minor will be replaced every 5 years and the major every 8 years. The company faces a tax rate of 30%. This is a normal project for the company, which has an asset beta of 0.9 and an equity beta of 1.0875. The company is 80% funded by equity and has just paid an annual dividend of 23.4 cents and its share price is 260cents. The risk free rate of interest is 4.35% and stock market risk premium is 5.5%. Ignore inflation. a) Calculate the cost of capital that would be used to evaluate this investment decission. b) work out the equivalent annual cost for each machine and explain which system you would choose. c) Book values or market values ? Indicate which one is used in calculating the WACC and why it is that one and not the other one.

The cost of debt need to be calculated from the information given.