Question

XYZ has a capital structure that is 35 % debt, 5 percent preferred stock, and 65 %common stock. The pretax cost of debt is 8.25 %, the cost of preferred is 8%, and the cost of common stock is 117%. The tax rate is 36%. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $550,000 and annual cash inflows of $130,000, $400,000, and $550,000 over the next 3 years, respectively. What is XYZ's WACC? What is the projected net present value of this project?

Answer #1

where w_{d} = weight of debt in capital structure

w_{p} = weight of preferred stock in capital
structure

w_{e} = weight of common stock in capital structure

r_{d} = cost of debt

rp = cost of preferred stock

re = cost of common stock

t = tax rate

Putting all the values in above equation, we get

WACC = 0.35 * 8.25 % * ( 1 - 0.36) + 0.05 * 8% + 0.65 * 11.7 %

= 9.85 %

Year | Cash Flows |

0 | - $ 550000 |

1 | $ 130000 |

2 | $ 400000 |

3 | $ 550000 |

= $ 130000 / ( 1 + 0.0985) + $ 400000 / ( 1 + 0.0985) + $ 550000 / ( 1 + 0.0985) - $ 550000

= $ 314688

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