You run a perpetual encabulator machine, which generates revenues averaging $20 million per year. Raw material costs
Question:
You run a perpetual encabulator machine, which generates revenues averaging $20 million per year. Raw material costs are 50% of revenues. These costs are variable—they are always proportional to revenues. There are no other operating costs. The cost of capital is 9%. Your firm’s long-term borrowing rate is 6%. Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $10 million per year for 10 years.
a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract?
b. Calculate the present value of the encabulator machine with and without the fixedprice contract.
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...
Step by Step Answer:
Principles of Corporate Finance
ISBN: 978-0077404895
10th Edition
Authors: Richard A. Brealey, Stewart C. Myers, Franklin Allen