Burke Enterprises is considering a machine costing $30 billion that will result in initial after-tax cash...

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Burke Enterprises is considering a machine costing $30 billionthat will result in initial after-tax cash savings of $3.7 billionat the end of the first year, and these savings will grow at a rateof 2 percent per year for 11 years. After 11 years, the company cansell the parts for $5 billion. Burke has a target debt/equity ratioof 1.2, a beta of 1.79. You estimate that the return on the marketis 7.5% and T-bills are currently yielding 2.5%. Burke has twoissuances of bonds outstanding. The first has 200,000 bonds tradingat 98% of par, with coupons of 5%, face of $1000, and maturity of 5years. The second has 500,000 bonds trading at par, with coupons of7.5%, face of $1000, and maturity of 12 years. Kate, the CEO,usually applies an adjustment factor to the discount rate of +2 forsuch highly innovative projects. Should the company take on theproject?

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4.3 Ratings (557 Votes)

Cost of equity risk free rate Beta market return riskfree rateCost of equity 25 179 75 25 1145Market value of first bond trading at 98 to par value 200000 1000 98 196 See Answer

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Burke Enterprises is considering a machine costing $30 billionthat will result in initial after-tax cash savings of $3.7 billionat the end of the first year, and these savings will grow at a rateof 2 percent per year for 11 years. After 11 years, the company cansell the parts for $5 billion. Burke has a target debt/equity ratioof 1.2, a beta of 1.79. You estimate that the return on the marketis 7.5% and T-bills are currently yielding 2.5%. Burke has twoissuances of bonds outstanding. The first has 200,000 bonds tradingat 98% of par, with coupons of 5%, face of $1000, and maturity of 5years. The second has 500,000 bonds trading at par, with coupons of7.5%, face of $1000, and maturity of 12 years. Kate, the CEO,usually applies an adjustment factor to the discount rate of +2 forsuch highly innovative projects. Should the company take on theproject?