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A company has a proposed 2-year project with the cash flows shown below and would like...

A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1, the risk-free rate is 4.2, and the expected market risk premium is 5.8%. The bonds for this company pay interest semiannually and have a coupon interest rate of 8%, 20 years to maturity, a face value of $1,000, and a current price of 937.07. If the corporate tax rate is 37%, what is the NPV of the proposed project for this firm? (Answer to the nearest dollar, but do not use a dollar sign).

Years Cash Flows

0 -2,000

1 1,000

2 3,000

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Homework Answers

Answer #1

Cots of equity using CAPM = Risk free rate + beta ( amrket risk premium)

cost of equity = 0.042 + 1 ( 0.058)

cost of equity = 0.10 or 10%

Coupon payment = 0.08 * 1000 = 80 / 2 = 40

Number of periods = 20 * 2 = 40

Before tax cost of debt using a financial calculator = 8.668%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PMT 40, N 40, PV -937.07, CPT I/Y

WACC = Weight of equity * cost of equity + weight of debt * after tax cost of debt

WACC = 0.6 * 0.10 + 0.4 * 0.08668 ( 1 - 0.37)

WACC = 0.06 + 0.021843

WACC = 0.081843 or 8.1843%

NPV = Present value of cash inflows - present value of cash outflows

NPV = -2000 + 1000 / ( 1 + 0.081843)1 + 3000 / ( 1 + 0.081843)2

NPV = $1,488

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