TrvlSafe, a manufacturer of air-freightable pet crates with imbedded chips to monitor the health of the pet, has identified two projects that have relatively high risk; however, they are expected to move the company into new revenue markets. Utilize a spreadsheet to determine: (a) Which of the two projects, if either, are acceptable when the MARR is equal to the after-tax WACC. (b) If the same projects are acceptable, provided the risk factors are significant and warrant an additional return of 2% per year above the established MARR.
Financing will be developed using a D-E mix of 60%–40% with equity funds costing 7.5% per year. Debt financing will be developed from $10,000, 5% per year, quarterly dividend, 10-year bonds. The effective tax rate is 30% per year.
Two independent, revenue projects with different lives. Find AW at MARR, select all
with AW > 0. Find WACC first.
Equity capital is 40% at a cost of 7.5% per year
Debt capital costs 5% per year, compounded quarterly. Effective after-tax rate is:
Effective after-tax debt cost = [(1 + 0.05/4)4 - 1] (1 - 0.3) (100%)
= 5.095(0.7)
= 3.566% per year
WACC = 0.4(7.5%) + 0.6(3.566%)
= 5.14% per year
MARR = WACC = 5.14%
(a) At MARR = 5.14%, both projects are acceptable (row 17)
(b) Project W is acceptable, since i*W = 14.04% > MARR + 2% = 7.14% (row 20)
Project R is not acceptable, since i*R = 6.40% < MARR + 2% = 7.14%
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