Question

Waterdeep Adventure Travel has an unlevered cost of equity of 11.2%, and a cost of debt of 7.2%. Their tax rate is 20%, and they maintain a capital structure of 42% debt and the rest equity. They are considering giving cave exploration tours to their menu of adventure vacations. Buying the needed equipment would cost $86,130, and would bring in $27,388 one year from today, and $84,798 two years from today. What is the NPV of this project, using the WACC method, if they invest today?

Answer is -10,456.773. How do I get there

Answer 1

In this question,

We have to calculate WACC i.e., Weighted Average Cost of Capital

Formula for WACC is as follows:

WACC = Ke x (%of equity) + Kd x (1 - tax) x (%of debt)

where

Ke = Cost of Equity = 11.20%

Kd = Cost of Debt = 7.20%

Tax = 20%

% of Debt = 42%

% of Equity = (100 - 42%) = 58%

WACC = 11.20 x 58% + 7.2 x (1-0.2) x 58%

WACC = 6.496 +2.419

WACC = 8.915%

Cash Flow	Present Value Factor @ 8.92%	Present Value
A	B	A x B
-86130	1	-86130
27388	0.92	25145.06
84798	0.84	71477.66
Net Present Value	10492.72

The NPV is positive and the difference in NPV may be because of approximation.

I hope it will help you in study.

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