Weighted Average Cost of Capital and Net Present Value Analysis Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $210,000, be useful for four years, and have a $16,000 salvage value. Tate expects annual savings in cash operating expenses (before taxes) $72,000. For tax purposes, the annual depreciation deduction will be $70,000, $94,000, S30,600, and $15,400, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%. Tate establishes a hurdle rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point. Tate's capital is provided in the following proportions: debt, 60%; common stock, 20%; and retained earnings, 20%. The cost rates for these capital sources are debt, 10%; common stock, 12%; and retained earnings, 13%. a. Compute Tate's (1) weighted average cost of capital and (2) hurdle rate. Round answers to one decimal place. For example, 0.4567 = 45,7%6. Weighted Average Cost of Capital Debt 6% Common stock Retained earnings (1) Weighted avg cost of capital 24% 26% 11 (2) Tate's hurdle rate: 12 b. Using Tate's hurdle rate, compute the net present value of this capital expenditure proposal, Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present välue to indicate a negative amount. Otherwise do not use negative signs with your answers. After-Tax Cash Flow Analysis Amount Present Value After-tax cash expense savings Tax savings from depreciation Year 1 Year 2 Year 3 Year 4 After-tax equipment sale proceeds Total present value of future cash flows Investment required in equipment Net positive (negative) present value
Weighted Average Cost of Capital and Net Present Value Analysis Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $210,000, be useful for four years, and have a $16,000 salvage value. Tate expects annual savings in cash operating expenses (before taxes) $72,000. For tax purposes, the annual depreciation deduction will be $70,000, $94,000, S30,600, and $15,400, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%. Tate establishes a hurdle rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point. Tate's capital is provided in the following proportions: debt, 60%; common stock, 20%; and retained earnings, 20%. The cost rates for these capital sources are debt, 10%; common stock, 12%; and retained earnings, 13%. a. Compute Tate's (1) weighted average cost of capital and (2) hurdle rate. Round answers to one decimal place. For example, 0.4567 = 45,7%6. Weighted Average Cost of Capital Debt 6% Common stock Retained earnings (1) Weighted avg cost of capital 24% 26% 11 (2) Tate's hurdle rate: 12 b. Using Tate's hurdle rate, compute the net present value of this capital expenditure proposal, Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present välue to indicate a negative amount. Otherwise do not use negative signs with your answers. After-Tax Cash Flow Analysis Amount Present Value After-tax cash expense savings Tax savings from depreciation Year 1 Year 2 Year 3 Year 4 After-tax equipment sale proceeds Total present value of future cash flows Investment required in equipment Net positive (negative) present value
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Using Tate's hurdle rate, how do I compute the
Transcribed Image Text:Weighted Average Cost of Capital and Net Present Value Analysis
Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $210,000, be useful for four years, and have a $16,000 salvage value. Tate expects annual savings in cash operating expenses (before taxes) of
$72,000. For tax purposes, the annual depreciation deduction will be $70,000, $94,000, $30,600, and $15,400, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40%.
Tate establishes a hurdle rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point. Tate's capital is provided in the following proportions: debt, 60%; common stock, 20%; and retained earnings, 20%. The cost
rates for these capital sources are debt, 10%; common stock, 12%; and retained earnings, 13%.
a. Compute Tate's (1) weighted average cost of capital and (2) hurdle rate.
Round answers to one decimal place. For example, 0.4567 = 45.7%.
Weighted Average Cost of Capital
Debt
6 %
Common stock
2.4 %
Retained earnings
2.6 %
(1) Weighted avg.cost of capital
11 96
(2) Tate's hurdle rate:
12 96
b. Using Tate's hurdle rate, compute the net present value of this capital expenditure proposal.
Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers.
After-Tax Cash Flow Analysis
Amount
Present Value
After-tax cash expense savings
Tax savings from depreciation
Year 1
0.
0.
Year 2
0.
Year 3
Year 4
0.
After-tax equipment sale proceeds
Total present value of future cash flows
Investment required in equipment
Net positive (negative) present value
%24
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