Part 1
A firm has the current liabilities and equity financing on its balance sheet. The firm has taxable income that puts it in a 38% federal tax bracket, and the state in which it operates levies a 6.5% income tax. Compute the firm’s weighted average cost of capital.
Source Amount Interest/RoR Proportion
Short-term loan $ 5,000,000 7.5% 0.05
Long-term loan $20,000,000 5.8% 0.25
Retained Earnings $25,000,000 17.0% 0.20
Common stock $50,000,000 22.0% 0.50
Part 2
The same firm is considering the following projects to improve its production process. If the firm has a capital budget of $1,400,000, which projects should be accepted by the rate of return criteria? What is the firm’s opportunity cost of capital?
Project First Cost Annual Benefit Life (years)
1 $250,000 $50,000 15
2 $300,000 $70,000 10
3 $125,000 $35,000 5
4 $ 50,000 $12,500 10
5 $250,000 $75,000 5
6 $200,000 $32,000 20
7 $400,000 $125,000 5
Part 3
From your estimates of the WACC in part 1 and the opportunity cost of capital in part 2, what do you estimate the firm’s true MARR to be?
2 answers