Question

Webster Corp. is planning to build a new shipping depot. The initial cost of the investment is $1.18 million. Efficiencies from the new depot are expected to reduce aftertax annual costs by $105,000 forever. The corporation has a total value of $62.4 million and has outstanding debt of $38.7 million. What is the NPV of the project if the firm has an aftertax cost of debt of 5.8 percent and a cost equity of 12.6 percent?

Answer 1

Weighted Average Cost of Capital (WACC)

Weight of Debt = 0.62019 [$38.70 Million / $62.40 Million]

Weight of Equity = 0.37981 [($62.40 Million - $38.70 Million) / $62.40 Million]]

After-tax Cost of Debt = 5.80%

Cost of Equity = 12.60%

Therefore, the Weighted Average Cost of Capital (WACC) = [After-tax cost of Debt x Weight of Debt] + [Cost of Equity x Weight of Equity]

= [5.80% x 0.62019] + [12.60% x 0.37981]

= 3.5971154% + 4.7855769%

= 8.3826923%

Net Present Value of the Project

Net Present Value of the Project = Present value of annual cash inflows – Initial investment cost

= (Annual savings / WACC) – Initial investment cost

= ($105,000 / 0.083826923) - $1,180,000

= $1,252,580.87 - $1,180,000

= $72,580.87 (Positive NPV)

Therefore, the Net Present Value of the Project is $72,580.87