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Case Study: NewCastle Limited - WACC

View Solution # 27151

Price: $5.00

Newcastle Ltd is all-equity financed and has a cost of capital of 15 percent. A consultant suggests that Newcastle could easily borrow up to 50% of the value of its assets at an interest rate of 10% and achieve a rating for its debt of A+ or better. He argues that raising new capital by borrowing would lower the company’s cost of capital, and increase the NPV of some projects that were recently rejected. Use a numerical example to illustrate the consultant’s argument. Is his argument correct? Explain and justify your answer.

Solution

The Company's cost of capital is computed using the Weighted Average Cost of Capital (WACC). A project which requires an investment of $280,000 and which will generate a cash flow of $50,000 for the next 10 years is analysed using the current and original WACC. The rationale behind the decision is also included.

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