A two-year project "High Horizon" will generate after-tax cash inflow of $3,009,913 at

the end of the first year and $2,769,991.67 at the end of the second year. Your company

currently has borrowing worth $149,815,110.40 for which the company is paying 7.4%

per year as cost of debt, and the shareholders of the company have invested a total of

$73,789,532; and they generally want a return of 15% per year. Corporate tax rate is at

37%. The project is somewhat riskier than the usual project your company undertakes,

and the management therefore uses the subjective approach and applies an adjustment

factor of +2.5% to the cost of capital for the project.

a) If your company is evaluating a new investment project that has the same risk as the

firm's typical project, what rate should your company use to discount the project's cash

flows? Show your calculation.

b) Under what circumstances in terms of the project cost should the company take on

the project "High Horizon"? Apply NPV rule in your analysis.

c) Discuss how your finding in part b) would go wrong if the rate in part a) is used to

evaluate the project.

Answer rating: 100% (QA)

a To determine the rate that should be used to discount the projects cash flows we need to calculate the cost of capital adjusted for the projects ris... View the full answer