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XYZ corporation is considering a capital project for the coming year
XYZ corporation is considering a capital project for the coming year.
The project has an internal rate of return of 14 percent. If the firm has the following target capital structure and costs, what should their decision be and why?
Source of Capital
Proportion
After-Tax Cost
Long-term debt
0.40
10%
Preferred stock
0.10
15%
Common stock equity
0.50
20%
Expert Solution
The company will have to take decision on the basis of comparison with the weighted average cost of capital.
WACC = Proportion of debt * weight of debt + Proportion of Preferred capital * weight of Preferred capital + Proportion of Equity capital * Weight of equity capital
= 0.40 * 10% + 0.10 * 15% + 0.50 * 20%
= 4% + 1.5% + 10%
= 15.5%
So the weighted average cost of capital is 15.50% whcih is higher than our internal rate of return(14%). So the project should not be accepted by the company.
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