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.**

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