Casper's is analyzing a proposed expansion project that is much riskier than the firm's current operations.Thus,the project will be assigned a discount rate equal to the firm's cost of capital plus 3 percent.The proposed project has an initial cost of $17.2 million that will be depreciated on a straight-line basis over 20 years.The project also requires additional inventory of $687,000 over the project's life.Management estimates the facility will generate cash inflows of $2.78 million a year over its 20-year life.After 20 years,the company plans to sell the facility for an estimated $1.3 million.The company has 60,000 shares of common stock outstanding at a market price of $49 a share.This stock just paid an annual dividend of $1.84 a share.The dividend is expected to increase by 3.5 percent annually.The firm also has 10,000 shares of 12 percent preferred stock with a market value of $98 a share.The preferred stock has a par value of $100.The company has a 9 percent,semiannual coupon bond issue outstanding with a total face value of $1.1 million.The bonds are currently priced at 102 percent of face value and mature in 16 years.The tax rate is 33 percent.Should the firm pursue the expansion project at this point in time? Why or why not?

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Quizplus · Accepted Answer

R_E = [($1.84 × 1.035)/$49] + 0.035 = 0.073865R_p = (0.12 × $100)/$98 = 0.122449 Project cost of capital = ($2,940,000/$5,042,000)(0.073865) + ($980,000/$5,042,000)(0.122449) + ($1,122,000/$5,042,000)(0.087652)(1 - 0.33) + 0.03 = 0.109939NPV = -$17.2m - $687,000 + $2.78m(PVIFA_{20, 10.9939%}) + ($1.3m + $687,000)/(1.109939)²⁰ = $4.507 millionThe firm should proceed with the expansion project because the NPV is positive.

Casper's Is Analyzing a Proposed Expansion Project That Is Much