Question

# Dyrdek Enterprises has equity with a market value of \$12.6 million and the market value of...

Dyrdek Enterprises has equity with a market value of \$12.6 million and the market value of debt is \$4.45 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 1.9 percent. The new project will cost \$2.56 million today and provide annual cash flows of \$666,000 for the next 6 years. The company's cost of equity is 11.79 percent and the pretax cost of debt is 5.06 percent. The tax rate is 40 percent. What is the project's NPV?

\$183,363

\$194,561

\$556,060

\$224,950

\$383,149

Step-1, Calculation of the Discount Rate to be used to discount the annual cash flows

After-tax Cost of Debt = Pre-tax Cost of Debt x (1 – Tax Rate)

= 5.06% x (1 – 0.40)

= 5.06% x 0.60

= 3.04%

Cost of Equity = 11.79%

Market Value of Debt = \$44,50,000

Market Value of Equity = \$1,26,00,000

Total Market Value = \$1,70,50,000

Weight of Debt = 0.2610 [\$44,50,000 / \$1,70,50,000]

Weight of Equity = 0.7390 [\$1,26,00,000 / \$1,70,50,000]

Weighted Average Cost of Capital (WACC) = (After-tax cost of Debt x Weight of Debt) + (Cost of Equity x Weight of Equity)

= (3.04% x 0.2610) + (11.79% x 0.7390)

= 0.7924% + 8.7128%

= 9.5052%

Discount Rate = Weighted Average Cost of Capital (WACC) + Risk adjustment factor

= 9.5052% + 1.90%

= 11.4052%

Step-2, Net Present Value (NPV) of the Project

Net Present Value (NPV) of the Project

 Year Annual Cash Flow (\$) Present Value factor at 11.4052% Present Value of Cash Flow (\$) 1 6,66,000 0.897624 5,97,818 2 6,66,000 0.805729 5,36,615 3 6,66,000 0.723242 4,81,678 4 6,66,000 0.649199 4,32,366 5 6,66,000 0.582737 3,88,103 6 6,66,000 0.523079 3,48,370 TOTAL 27,84,950

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= \$27,84,950 - \$25,60,000

= \$224,950

“Therefore, the Net Present Value (NPV) of the Project would be \$224,950”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.

#### Earn Coins

Coins can be redeemed for fabulous gifts.