Now assume that Plastico is considering a project that requires an initial investment of $100 million and has the following projected income statement (depreciation for the project is expected to be $5 million a year forever):
EBIT ........... $20 million
−Interest ........... $4 million
EBT ............ $16 million
Taxes ............. $6.40 million
Net income .......... $9.60 million
This project is going to be financed at the same debt/equity ratio as the overall firm and is expected to last forever. Assume that there are no principal repayments on the debt (it too is perpetual).
a. Evaluate this project from the equity investors’ standpoint. Does it make sense?
b. Evaluate this project from the firm’s standpoint. Does it make sense?
c. In general, when would you use the cost of equity as your discount rate/benchmark?
d. In general, when would you use the cost of capital as your benchmark?
e. Assume, for economies of scale, that this project is going to be financed entirely with debt. What would you use as your cost of capital for evaluating this project?