Corporate Finance Q86
86Information about a company is provided below. It is expected that the company will fund its capital budget without issuing any additional shares of common stock:
| Source of capital | Capital structure proportion | Marginal after-tax cost |
| Long-term debt | 30% | 12% |
| Preferred stock | 5% | 15% |
| Common equity | 65% | 20% |
Net present values of three independent projects: Storage project: $348 Upgrade project: $0
Production line improvement project: -$231 If no significant size or timing differences exist among the projects and the projects all have the same risk as the company, which project has an internal rate of return that exceeds 17.35 percent?
Production line improvement project: -$231 If no significant size or timing differences exist among the projects and the projects all have the same risk as the company, which project has an internal rate of return that exceeds 17.35 percent?
- Option : B
- Explanation : The WACC of the company is calculated as follows: 0.3(12%) + 0.05(15%) + 0.65(20%) = 17.35%. To have a positive NPV, a project must have an IRR greater than the WACC used to calculate the NPV. Only the storage project has a NPV greater than $0 (at the company’s WACC of 17.35%), therefore only the storage project has an IRR that exceeds 17.35%.
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