Deavyanne Johnston, the engineering manager at TZO Chemicals, is conducting an evaluation of alternatives based on ROR. She was given the following data and told that due to the unusually large number of investment opportunities the company now has, all future projects must have a ROR that is at least 12.5% above the company’s weighted average cost of capital on an after-tax basis. If the company’s effective tax rate is 32%, what is the after-tax MARR she should use in her evaluation?
What will be an ideal response?
MARR = WACC + 12.5%. Total equity and debt fund is $15 million. Debt capital gets a tax break; equity does not. From Equation [10.4]
After-tax cost of debt = 10.4%(1 - 0.32) = 7.072%
After-tax WACC = equity cost + debt cost
= (4/15)(7.4%) + (6/15)(4.8%) + 5/15(7.072%)
= 1.973 + 1.920 + 2.357
= 6.25%
After-tax MARR = 6.25 + 12.5
= 18.75%
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