Based on market values, Gubler's Gym has an equity multiplier of 1.67 times. Shareholders require a...

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Based on market values, Gubler's Gym has an equity multiplier of1.67 times. Shareholders require a return of 11.75 percent on thecompany's stock and a pretax return of 5.05 percent on thecompany's debt. The company is evaluating a new project that hasthe same risk as the company itself. The project will generateannual aftertax cash flows of $319,000 per year for 8 years. Thetax rate is 39 percent. What is the most the company would bewilling to spend today on the project?

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3.7 Ratings (717 Votes)

A/E = 1.67

E/A = 1/1.67=0.5988

D/A = 1-E/A = 1-0.5988=0.4012

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.05*(1-0.39)

= 3.0805

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=3.08*0.4012+11.75*0.5988

WACC =8.27%

Project
Discount rate	8.2718170%
Year	0	1	2	3	4	5	6	7	8
Cash flow stream	0	319000	319000	319000	319000	319000	319000	319000	319000
Discounting factor	1.000	1.083	1.172	1.269	1.374	1.488	1.611	1.744	1.889
Discounted cash flows project	0.000	294628.841	272119.606	251330.044	232128.777	214394.459	198015.019	182886.946	168914.636
NPV = Sum of discounted cash flows
NPV Project =	1814418.33
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

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