Reference no: EM133003759

Austin, Inc. is evaluating an expansion project that will last 3 years. The project has the same risk as the firm's current operations and the firm is in the 40 percent tax bracket. The project will require equipment costing $850,000 and an increase in net working capital of $60,000. The equipment is expected to have a salvage value of $275,000 at the end of the project. Sales are forecasted to be $1.2 million annually, with costs at 45 percent of sales. The equipment falls in the MACRS 3-year asset class.

The common stock of Austin, Inc. has a beta of 1.6 and maintains a constant growth rate in dividends of 7.6 percent. The firm just paid a $1.35 annual dividend yesterday and there are 22 million common shares outstanding. The firm also has 5 million shares of preferred stock outstanding that currently have a dividend yield of 9 percent and pay a $3.24 annual dividend, of which the most recent one was paid yesterday. The 10 year Treasury is yielding 4 percent and you use a 6 percent estimate for the market risk premium. Further, you are instructed to only use the CAPM to estimate the required return on common stock (i.e., ignore other methods).

Austin, Inc. has 200,000 bonds outstanding that mature in 12 years, have a $1,000 face value, and make semiannual coupon payments. The coupon rate is 8 percent and they currently have a yield to maturity of 7 percent. Assume the firm made its most recent coupon payment yesterday. Should the firm invest in this project?