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Universal Foods has a debt-to-value ratio of 30%, its debt is currently selling on a yield of 8%, and its cost of equity is 16%
Universal Foods has a debt-to-value ratio of 30%, its debt is currently selling on a yield of 8%, and its cost of equity is 16%. The corporate tax rate is 21%. The company is now evaluating a new venture into grocery delivery systems. The internal rate of return on this venture is estimated at 12%. WACCs of firms in the grocery delivery service industry tend to average around 15%.
a. What is Universal's WACC?
b. Will Universal make the correct decision if it discounts cash flows on the proposed venture at the firm's WACC?
c. Should the new project be pursued?
Expert Solution
b. No, as it should use WACC based on projects industry i.e. 15%.
c. No, as its WACC for the industry is 15% whereas the return from project is 12% which is lower than the WACC.
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