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Weighted Average Cost of Capital and Net Present Value Analysis Manchester Company is considering a proposal to purchase special equipment at a cost of $700,000.
Weighted Average Cost of Capital and Net Present Value Analysis Manchester Company is considering a proposal to purchase special equipment at a cost of $700,000. The equipment will be useful for five years and has an expected $75,000 salvage value. Manchester expects annual savings in cash operating expenses (before taxes) of $245,000. For tax purposes, the annual depreciation deduction will be as follows (salvage value is ignored on the tax return): Year 1 $87,500 Year 2 175,000 Year 3 75,000 Year 4 175,000 Year 5 87,500 The income tax rate is 40%. Manchester establishes a cutoff rate for a net present value analysis at the company's weighted average cost of capital plus 2 percentage points. Manchester's capital is provided in the following proportions: debt, 70%; common stock, 20%; and retained earnings, 10%. The cost rates for these capital sources are debt, 8%; common stock, 12%; and retained earnings, 10% a. Compute Manchester's (1) weighted average cost of capital and (2) cutoff rate. Round answers to one decimal place. For example, 0.4567 E 45.7%. Weighted Average Cost of Capital 5.6 96 Debt Common stock 2.4 Retained earnings 9 96 (1) Weighted avg. cost of capital 11 (2) Manchester's cut off rate: 89§ion 1
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