Based on market values, Gubler's Gym has an equity multiplier of 1.52 times. Shareholders require a...

Based on market values, Gubler's Gym has an equity multiplier of 1.52 times. Shareholders require a return of 11.15 percent on the company's stock and a pretax return of 4.90 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $289,000 per year for 9 years. The tax rate is 39 percent. What is the most the company would be willing to spend today on the project?

Multiple Choice

$1,731,793
$1,778,775
$1,626,236
$2,050,380
$1,682,313

Expert Solution

Step 1 :	Calculation of WACC

	Equity multiplier = Total Assets / Equity

	1.52 =Total Assets / Equity

	Total Assest = 1.52 Equity

	Weight of equity = 1/1.52
	=65.79%

	Weight of Debt =100%-65.79%
	=34.21%


	After-tax cost of debt = cost of debt ×(1-tax rate)

	=0.049× (1-0.39)

	=0.049× 0.61
	=2.99 %

	WACC= (Cost of Debt * Weight Of Debt)+ (Cost of Equity * Weight of equity)


	=(0.02990.3421) + (0.11150.6579)

	=0.01022879+0.07335585

	=8.36%



Step 2:	Calculation of company willing to pay

	Present Value Of An Annuity
	= C*[1-(1+i)^-n]/i]

	Where,
	C= Cash Flow per period
	i = interest rate per period
	n=number of period

	= $289000[ 1-(1+0.0836)^-9 /0.0836]

	= $289000[ 1-(1.0836)^-9 /0.0836]

	= $289000[ (0.5145) ] /0.0836

	= $17,78,775 (rounded off)

jeff jeffy answered 2 years ago

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