principles of managerial finance 14th ed, question p9-1
Basic variables North South
Cost $6 million $5 million
Life 15 years 15 years
Expected return 8% 15%
Least-cost financing
Source Debt Equity
Cost (after-tax) 7% 16%
Decision
Action Invest Donât invest
Reason 8% . 7% cost 15% , 16% cost
a. An analyst evaluting the North facility expects that the project will be financed
by debt that costs the firm 7%. What recommendation do you think this analyst
will make regarding the investment opportunity?
b. Another analyst assigned to study the South facility believes that funding for that
project will come from the firmâs retained earnings at a cost of 16%. What recommendation
do you expect this analyst to make regarding the investment?
c. Explain why the decisions in parts a and b may not be in the best interests of the
firmâs investors.
d. If the firm maintains a capital structure containing 40% debt and 60% equity,
find its weighted average cost using the data in the table.
e. If both analysts had used the weighted average cost calculated in part d, what recommendations
would they have made regarding the North and South facilities?
f. Compare and contrast the analystâs initial recommendations with your findings
in part e. Which decision method seems more appropriate? Explain why.
principles of managerial finance 14th ed, question p9-1
Basic variables North South
Cost $6 million $5 million
Life 15 years 15 years
Expected return 8% 15%
Least-cost financing
Source Debt Equity
Cost (after-tax) 7% 16%
Decision
Action Invest Donât invest
Reason 8% . 7% cost 15% , 16% cost
a. An analyst evaluting the North facility expects that the project will be financed
by debt that costs the firm 7%. What recommendation do you think this analyst
will make regarding the investment opportunity?
b. Another analyst assigned to study the South facility believes that funding for that
project will come from the firmâs retained earnings at a cost of 16%. What recommendation
do you expect this analyst to make regarding the investment?
c. Explain why the decisions in parts a and b may not be in the best interests of the
firmâs investors.
d. If the firm maintains a capital structure containing 40% debt and 60% equity,
find its weighted average cost using the data in the table.
e. If both analysts had used the weighted average cost calculated in part d, what recommendations
would they have made regarding the North and South facilities?
f. Compare and contrast the analystâs initial recommendations with your findings
in part e. Which decision method seems more appropriate? Explain why.
Related questions
Concept of cost of capital Mace Manufacturing is in the process of analyzing its investment decision making procedures. Two projects evaluated by the firm recently involved building new facilities in differnt regions, North and South. The basic variables surrounding each project analysis and the resulting decision arctions are summarized in the following table
a. an analyst evaluating the North facility expects the project will be financed by debt that costs the firm 7%. What recommendations do you think thes analyst will make regarding the investment opportunity?
b. Another analyst assged to study the South facility believes that the funding for that project will come from the firm's retained earnings at a cost of 16%. What recommendations do you think thes analyst will make regarding the investment opportunity?
c. Explain why the decisions in part a and b may not be in the best interest of the firm's investors.
d. If the firm maintains a capital structure containing 40% debt and 60% equity, find it weighted average cost using data in the table.
e. If both analysts had used the weighted average cost calculated in part d, what recommendations would they ahve made regarding the North and South facilities?
f. Compare and contrast the analyst's initial recommendation with your finding in part e. Which decision method seems more appropriate? Why?
| Basic Variables | North | South |
| Cost | $ 6,000,000 | $ 5,000,000 |
| Life | 15 | 15 |
| Expected Returns | 0.08 | 0.15 |
| Least Cost Financing | ||
| Source | Debt | Equity |
| Cost (after-tax) | 0.07 | 0.16 |
| Decision | ||
| Action | Invest | Don't Invest |
| Reason | .08>.07 | .15<.16 |
