Question

Based on market values, Gubler's Gym has an equity multiplier of 1.62 times. Shareholders require a return of 11.55 percent on the company's stock and a pretax return of 5.00 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $309,000 per year for 7 years. The tax rate is 40 percent. What is the most the company would be willing to spend today on the project

Answer 1

the maximum amount spend today is $1,593,476.83

Step-by-step explanation:

The computation of the maximum amount spend today is shown below:

But before that the cost of capital is

cost of capital = (1 - 1 ÷ 1.62) × 5% × (1 - 40%) + (1 ÷ 1.62) × 11.55%

= 8.28%

Now

The Maximum amount to be spent is

= $309,000 ÷ 8.28% × (1-1 ÷ (1 + 8.28%)^7)

= $1,593,476.83

Hence, the maximum amount spend today is $1,593,476.83