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

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Finance

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?

Answer & Explanation Solved by verified expert
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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Transcribed Image Text

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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