Question

A firm with no preferred stock outstanding has a debt-to-equity ratio of D/E = 1.25, an effective annual before-tax cost of debt of 6.5%, and a cost of equity of 14.2%. Additionally, the firm faces a 32% tax rate.

A firm is considering a project with zero NWC or salvage cash flows. What is the NPV of a project with an initial investment of $12 million that generates incremental after-tax cash flows of OCF= $2,000,000 per year over the project's 10 year life?

please do not use excel

Answer 1

Debt-equity ratio=1.25

Hence, Ratio of debt= 1.25/2.25

Ratio of equity= 1/ 2.25

Weighted average cost of capital = weight of debt*pre tax cost of debt(1-tax rate) +weight of equity*cost of equity

=1.25/2.25*6.5(1-0.32)+1/2.25*14.2%

=8.766%

Inflow=$2,000,000 every year for 10 years

Present value of inflow= $2,000,000 *Present value annuity factor for 10 years at 8.766%

=$2,000,000*6.48429=$12,968,581.48

NPV=Present value of inflow-present value of outflow

=$12,968,581.48-12,000,000 =$968,581.48