Lawler's is considering a new project.The company has a debt-equity ratio of .64.The company's cost of equity is 14.9 percent, and the aftertax cost of debt is 5.3 percent.The firm feels that the project is riskier than the company as a whole and that it should use an adjustment factor of +1.8 percent.What is the project cost of capital if the tax rate is 34 percent?

Question

Quizplus · Accepted Answer

The project cost of capital is the weighted average cost of capital (WACC) of the project. The WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)where:E = market value of the firm's equityV = market value of the firmRe = cost of equityD = market value of the firm's debtRd = cost of debtT = tax rateIn this case, the debt-equity ratio is .64, the cost of equity is 14.9 percent, the aftertax cost of debt is 5.3 percent, and the tax rate is 34 percent. The project is riskier than the company as a whole, so an adjustment factor of +1.8 percent is used.Therefore, the project cost of capital is:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)= (1/(1+.64)) * 14.9% + (.64/(1+.64)) * 5.3% * (1 - 34%)= 12.95%

Lawler's Is Considering a New Project