Auto Inc., an automobile manufacturer with a current debt-to-equity ratio of 2, is considering expanding its operations to produce bicycles. Unsurprisingly, the bicycle industry faces a different set of risks than the automobile industry. However, the executives at Auto Inc. observe that Bike Inc., a bicycle company, has a cost of equity of 16%, a cost of debt of 6%, and a debt-to-value ratio of 60%. Auto Inc. plans to finance its expansion into bicycle production with 20% debt and 80% equity. The cost of debt for Auto Inc. is also 6%, and the corporate tax rate is 25%. Solve for the discount rate that Auto Inc. should use when evaluating whether to go forward with the expansion. Note: Auto Inc. does not want to use the Adjusted Present Value method.
Auto Inc., an automobile manufacturer with a current debt-to-equity ratio of 2, is considering expanding its operations to produce bicycles. Unsurprisingly, the bicycle industry faces a different set of risks than the automobile industry. However, the executives at Auto Inc. observe that Bike Inc., a bicycle company, has a
Note: Auto Inc. does not want to use the Adjusted Present Value method.
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