Question

One of the capital expenditure projects included in a company’s capital budget was a $10 million investment for the construction of a new manufacturing facility in South America. The preliminary information provided by the financial analysis department of the company indicated that the project would earn an 8% return on investment. The treasurer met several investors who showed an interest in the project and were prepared to provide the following:
Common shares ........ $ 3,500,000
Retained earnings ....... 500,000
Preferred shares .......... 1,000,000
Bonds ............. 5,000,000
Total ............. $10,000,000
The cost of capital for each source of financing is as follows:
• Common shares ........ 12.0%
• Retained earnings ........ 11.0%
• Bonds ............ 7.5%
• Preferred shares ........ 10.0%
The company’s corporate income tax rate is 45%.
The members of the management committee were reviewing all projects in the capital budget. When they examined the $10 million manufacturing facility, several showed some concern about the project’s viability and were unsure whether it should be approved.

Ignoring flotation costs or brokers’ fees, calculate the cost of capital for raising the $10 million. Should the management committee approve this project? Why?



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  • CreatedDecember 03, 2014
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