Question

Universal Foods has a debt-to-value ratio of 36%, its debt is currently selling on a yield of 8%, and its cost of equity is 12%. The corporate tax rate is 40%. The company is now evaluating a new venture into home computer systems. The internal rate of return on this venture is estimated at 13.4%. WACCs of firms in the personal computer industry tend to average around 14%.

a. What is Universal's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
WACC
b. Will Universal make the correct decision if it discounts cash flows on the proposed venture at the firm's WACC?
A. Yes
B. No
c. Should the new project be pursued?
A. Yes
B. No

Answer 1

A. 9.41%

B. No

C. No

Step-by-step explanation:

a. Calculation to determine Universal's WACC

Using this formula

rEquity = (D / V) × (1 - Tc)rDebt + (E / V) × rEquity

Let plug in the formula

rEquity= 0.36× (1 - 0.40)(0.08) + (1 - 0.36) × 0.12

rEquity=0.36×(0.60)(0.08)+(0.64)×0.12

rEquity=(0.36×0.048)+0.0768

rEquity=0.01728+0.0768

rEquity=0.0941*100

rEquity=9.41%

Therefore Universal's WACC is 9.41%

b. No. Based on the above calculation the Universal would not make the correct decision if it discounts cash flows on the proposed venture at the firm's WACC reason been that it is above the company WACC.

c. No. The new project should not be pursued reason been that the INTERNAL RATE OF RETURN( IRR ) is lower than the required discount rate of 14% and it tend to have a negative NET PRESENT VALUE (NPV).