A firm is considering a project that will generate perpetual cash flows of $50,000 per year beginning next year.The project has the same risk as the firm's overall operations.If the firm's WACC is 12.0%,and its debt-to-equity ratio is 1.33,what is the most it could pay for the project and still earn its required rate of return?

Question

Quizplus · Accepted Answer

To calculate the maximum price the firm could pay for the project and still earn its required rate of return, we need to use the perpetuity formula:

PV = CF / r

Where PV is the present value of the perpetuity, CF is the cash flow generated each year, and r is the required rate of return.

We know that CF = $50,000 and r = WACC = 12.0%.

To calculate the PV, we first need to calculate the perpetuity factor, which is:

Perpetuity factor = 1 / r

= 1 / 0.12
= 8.3333

Now we can use the perpetuity formula:

PV = CF / r
PV = $50,000 / 0.12
PV = $416,667

This means that the most the firm could pay for the project and still earn its required rate of return is $416,667. Therefore the correct answer is choice C.

A Firm Is Considering a Project That Will Generate Perpetual