Question

Wyatt Oil is considering an investment in a new project with an unlevered cost of capital of 11%. Wyatt's marginal corporate tax rate is 35% and its debt cost of capital is 6%. The project has free cash flows of $25 million per year which are expected to decline by 3% per year.


If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%, then the value of this new project is closest to:

Group of answer choices

$188 million

$188.5 million

$320 million

$340 million

Answer 1

Wacc for the project = unleverd cost of capital - tax rate * cost of debt

= 11% - 35% * 6% = 10.267%

Present value for growing perpetuity = Cash flows / Wacc - Growth rate

Since there is an decline instead of growth the formula will be = Cash flows / Wacc + decline rate

= 25 million / 10.267 + 3%

= 25 million / 13.267%

= $ 188.5 million.