Question

Watson, Inc., is an all-equity firm. The cost of the company’s equity is currently 12 percent, and the risk-free rate is 4 percent. The company is currently considering a project that will cost $11.55 million and last six years. The company uses straight-line depreciation. The project will generate revenues minus expenses each year in the amount of $3.25 million. If the company has a tax rate of 35 percent, what is the net present value of the project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Net present value $

Answer 1

Depreciation = Cost of the Project / Life years

= $11,550,000 / 6 = $1,925,000

After-Tax Cfs = [(Revenues - Expenses) x (1 - t)] + [Depreciation x Tax Rate]

= [$3,250,000 x (1 - 0.35)] + [$1,925,000 x 0.35]

= $2,112,500 + $673,750 = $2,786,250

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

= [$2,786,250 / 1.12] + [$2,786,250 / 1.12²] + [$2,786,250 / 1.12³] + [$2,786,250 / 1.12⁴] +

[$2,786,250 / 1.12⁵] + [$2,786,250 / 1.12⁶] - $11,550,000

= $2,487,723.21 + $2,221,181.44 + $1,983,197.72 + $1,770,712.25 + $1,580,993.08 +

$1,411,600.96 - $11,550,000

= -$94,591.34