Question

Fauji Foods Ltd. is considering a project of new product line that requires the initial cost of Rs. 12 million. The company is
considering to raise the capital from debt, equity and preferred stock. The target capital structure is 35% debt, 10% preferred,
and 55% common equity. The interest rate on new debt is 6.50%, the cost of preferred stock is 6.00%, and the cost of equity is
11.25%, and the tax rate is 40%.
The project has an economic life of 7 years and has the following projected cash flow data.
Year 0 1 2 3 4 5 6 7__
Cash flows Rs. (12m) Rs.1.0m Rs.1.75m Rs.4.0m Rs.4.2m Rs.3.0m Rs.2.2m Rs.2.0m
a) What is the weighted cost of capital (WACC)? (in calculation only round of the final value to two decimal points)
b) What is the project's NPV?
c) What is the project's IRR?
d) Appraise the project using both NPV and IRR evaluation techniques.

Answer 1

(a.) Calculation of WACC :

WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of Preferred Stock * Weight of Preferred Stock) + ( Cost of Equity * Weight of Equity)

= [6.50% * (1 - 0.40) * 0.35] + (6% * 0.10) + (11.25% * 0.55)

= 1.365% + 0.6% + 6.1875%

= 8.1525% or 8.15%

(b.) Calculation of NPV

NPV = $1.21 million or $1,211,198.45

(c.) Calculation of IRR

IRR = 10.84%

(d.) The project should be accepted because it has positive NPV and its IRR is more than its weighted average cost of capital.