Question

Super Sports Fitness (SSF) is planning a project in Saskatoon. The project needs $224 million of additional capital and all have to be raised externally. SSF would like to keep its debt to equity ratio at 1.25. Waseem, the financial manager of SSF, estimates the after-tax cost of equity at 18% while the after-tax cost of debt is at 5%. As percentage of the amount raised, the flotation costs of debt are 4% while the flotation costs of equity are 7%. The project will generate $60 million cash per year for 6 years after which the salvage value will be zero. What is the NPV of the project?

Answer 1

D/E = 1.25

D = 1.25E

If E = 1, D = 1.25

Weight of debt (Wd) = 1.25/(1+1.25) = 0.5556

Weight of equity (We) - 1 -0.5556 = 0.4444

Cost of equity (after floatataion cost) = 18%*(1+0.07) = 19.26%

After tax cost of debt (after floatation) = 5%*(1+0.04) = 5.2%

WACC = 0.5556*5.2 + 0.4444*19.26 = 11.45%

NPV of the project is = 60/(1+0.1145) + 60/(1+0.1145)^2 + 60/(1+0.1145)^3 + 60/(1+0.1145)^4 + 60/(1+0.1145)^5 + 60/(1+0.1145)^60 -224 = -4.64 Million

Since the NPV is negative, we do not recommend the project