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Question - Macob Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent.
a. What is the firm's weighted average cost of capital?
b. The company is considering a project that will result in initial aftertax cash savings of $2.7 million at the end of the first year, and these savings will grow at a rate of 4% per year indefinitely. This project is somewhat riskier than the usual project the firms undertakes, and management uses an adjustment factor of +2% to the cost of capital for such risky projects. Under what circumstances should the company take on the project?
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