Your company is evaluating two projects and has collected the following information:

	Project A	Project B
Expected return (IRR)	12%	7%
Risk	Same as existing business	Same as existing business
Suggested source of financing	Equity	Long-term debt
After-tax cost of financing	16%	5%

The company currently has a capital structure consisting of 50% equity and 50% long-term debt.

Without doing any calculations, what should the company do and why?

Look for a better reason to make a decision

Accept only project A, since its expected return is greater than project B's

Accept only project B, since its cost of financing is less than project A's

Accept both projects, since they are not riskier than the existing business

Reject both projects, since their expected returns are too low

Accept only project B, since its expected return is greater than its cost of financing

What is the firm's overall (after-tax) cost of capital?

Correct

The firm is financed with 50% equity and 50% debt. The table tells us that the cost of equity and debt are as follows:

KE =0.16 =0.16 KD(1t)=0.05(1-)=0.05

Weighted average cost of capital:

WACC=ED+EKE+DD+EKD(1t)WACC=+++(1-)

= 0.50.16+0.50.050.50.16+0.50.05

= 0.105

What should the firm do?

Accept project B and reject project A

Something else

Accept project A and reject project B

Accept both projects

Reject both projects