The new project is likely to give a rate of return of 14% before taxes.An investment company is willing to finance the project through a private placement of 5 crore in the form of 10% p.a. interest bearing bonds. Apollo's shares have historically been selling at P/E of 10. Current earnings are Rs.2.70 and the company is in the 50% tax bracket.

The present Capital structure of the company is:

oLong term debt (8%) 1,00,00,000

oCommon Stock (Rs.2 par value, 1 crore shares outstanding) 2,00,00,000

oRetained earnings = 17,00,00,000

oTotal capital 20,00,00,000 before tax marginal

ocost of the project is 10% (interest on new loan) and the likely before tax returns from the project are higher than 10% the company should go ahead.

Discuss. P/E declines to 9, what level of annual earnings (before interest and taxes) must the new project generate in order to meet the company's objective of no change in the value of the stock price.

Answer rating: 100% (QA)

To evaluate whether the company should go ahead with the new project we need to consider the rate of return of the project the financing cost and the ... View the full answer