A product manager is evaluating a new product with a 5-year production span. The forecasted annual sales are 15.000 units, real annual production costs are 12,000 and the real per unit price is constant at 2 at t=0 (today). The production requires the purchase today of 45,000 (real) of new machinery, which will be fully straight-line depreciated over the next 5 years, the use of currently owned equipment which has been fully depreciated and would make a net after tax profit of 25,000 if sold today and land of 100,000 (nominal) which will be sold at the end of production for 100,000 (nominal). Overheads and general expenditures are estimated at $5,000 (real) in the first year, increasing by 5% per year in real terms. The tax rate is 40%, the required return on equity is 14%, the nominal debt rate is 5%, inflation is 7% and the target debt ratio is 30% and depreciation is straight-line. All cash flows occur at year's end and the firm has other profitable ongoing operations.  

(A) Find the firm's weighted average cost of capital.  

(B) Suppose that the land purchase is financed via a 5-year loan at the nominal debt rate whose principal is repaid in full at maturity by using resources from the other activities of the firm. What is the APV of the project?

Answer rating: 100% (QA)

A Weighted Average Cost of Capital WACC To calculate the WACC we need to first determine the cost of equity and the cost of debt Cost of equity The co... View the full answer