Reference no: EM133121093

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 different? regions, North and South. The basic variables surrounding each project analysis and the resulting decision actions are summarized in the following? table.

Basic variables: cost

North: $4,000,000

South: $3,640,000

Basic variables: life

North: 20 years

South: 20 years

Basic variables: expected return

North: 8.3%

South: 14.8%

Basic variables: Least-cost financing source

North: Debt

South: Equity

Basic variables: Cost (after tax)

North: 6.1%

South: 16.9%

Basic variables: Decision Action

North: Invest

South: Don't invest

Basic variables: Decision reason

North: 8.3%>6.1% cost

South: 14.8%<16.9% cost

a. An analyst evaluating the North facility expects that the project will be financed by debt that costs the firm 6.1%. 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? firm's retained earnings at a cost of 16.9?%. 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 interest of the? firm's 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? analysts' initial recommendations with your findings in part e. Which decision method seems more? appropriate? Explain why.