Should wgg purchase the equipment

Reference no: EM133269712

Question - WGG Co. shares have a required rate of return of 12%. WGG bonds carry an 8.00% coupon rate and a yield to maturity of 7.00%. The market value of the bonds is $400 million. WGG stock, of which 40 million shares are outstanding, sells for $15 per share. The corporate tax rate is very favourable at a low rate of 20%. No preferred shares are outstanding.

WGG must decide whether or not to purchase additional capital equipment. The cost of the equipment is $20 million. The expected after-tax net cash flows from the new equipment are $3 million a year for the first 5 years and $2.5 million a year for another 5 more years. The salvage value is 0.

Should WGG purchase the equipment? (Note: The depreciation tax savings are already included in the calculation of after-tax net cash flows).

Reference no: EM133269712

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