Suppose Luther Industries Is Considering Divesting One of Its Product

question 71

Essay

Suppose Luther Industries is considering divesting one of its product lines.The product line is expected to generate free cash flows of $2 million per year,growing at a rate of 3% per year.Luther has an equity cost of capital of 10%,a debt cost of capital of 7%,a corporate tax rate of 21%,and a debt-equity ratio of 2.If this product line is of average risk and Luther plans to maintain a constant debt-equity ratio,what after-tax amount must it receive for the product line in order for the divestiture to be profitable?

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Definitions:

Parallel Connection

An arrangement in electrical circuits where components are connected across common junction points, allowing each component to operate independently of the others.

Frequency Source

An electronic device or system that generates a repetitive signal of a fixed, specified frequency.

Anti-Federalist

Individuals opposed to the ratification of the U.S. Constitution in the late 18th century, fearing it concentrated too much power at the federal level and lacked sufficient protection for individual rights.

Liberty

A fundamental principle referring to the freedom of individuals to live their life without restrictive laws, interference from others, or governmental control, except under the law.