Pedro's Plumbing has a number of retail outlets in the Ottawa area. The company's capital structure consists of $40,000,000 of long-term debt, which carries an interest rate of 8% (the tax rate is 25%), and $60,000,000 of equity, on which the shareholders expect a return of 20%. Required (a) Calculate the weighted average cost of capital. ( b ) If the company used $40,000,000 of surplus cash to repay the debt, what would happen to the weighted average cost of capi- tal? (c) If the company borrowed an additional $40,000,000 and used it to pay the shareholders a $40,000,000 dividend, what would happen to the weighted average cost of capital? 13. Pedro's Plumbing uses an interest rate of 20% to evaluate new investment projects. The company is considering a new in-store security system for its Carlton Place branch. The system is budgeted to cost $654,900. The cost will be depreciated over its expected use- ful life of five years. The new system should increase cash flows by reducing stock shrinkage by $200,000 per year for five years. Because the project is considered to be low risk, it has been sug- gested that it be evaluated using an interest rate of 14%, not 20%. Required (a) Calculate the net present value at the normal rate of 20%. (b) Calculate the net present value at the low risk rate of 14%. (c) What would happen if the project were to be evaluated at a rate of 16%?

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