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Halifax Inc. is considering a project that requires an initial investment of $10 million and promises to generate an annual after-tax cash flow of $1 million perpetually. This firm is only financed by common shares and debt. In its capital structure it has 40% debt, and it wants to maintain this capital structure in future. It has bonds outstanding with a coupon rate of 8% (with semiannual coupon payment), and these bonds mature in 10 years. The bonds are currently selling at 93% of their par value. Current market risk premium is 6% and risk free rate is 4%. The firm has the same level of systematic risk as the market. The firm’s tax rate is 32%. The firm does not have any internal capital for this project. Floatation cost for stocks and bonds are 4% and 2%, respectively, for this firm. Assume governmental tax authority allows firms to deduct floatation costs from taxes by amortizing over 5 years (on a straight line basis). That is, over 5 years the firm may get tax deduction on five equal amounts of the total floatation cost. As a policy the firm always use its weighted average cost of capital to discount its tax deductions for floatation costs. Given the information provided. Should the firm take the project? Complete your calculation and make your conclusion.
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