Question

Dyrdek Enterprises has equity with a market value of $12.1 million and the market value of debt is $4.20 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 1.7 percent. The new project will cost $2.46 million today and provide annual cash flows of $641,000 for the next 6 years. The company's cost of equity is 11.59 percent and the pretax cost of debt is 5.01 percent. The tax rate is 35 percent. What is the project's NPV?

Answer 1

Cost of Equity = 11.59%, Cost of Debt = 5.01 % and Tax Rate = 35 %

Market Value of Equity = E = $ 12.1 million and Market Value of Debt = D = $ 4.2 million

Value of Firm = D + E = 4.2 + 12.1 = $ 16.3 million

Weighted Average Cost of Capital (WACC) = 11.59 x (12.1 / 16.3) + 5.01 x (4.2 / 16.3) x (1-0.35) = 9.44272 %

Risk Adjustment Factor (RAF) = 1.7 %

Therefore, Appropriate Project Discount Rate = WACC + RAF = 9.44272 + 1.7 = 11.1427 %

New Project Cost = $ 2.46 million and Annual Cash Flow = $ 641000

Project Tenure = 6 years

Therefore, NPV = 641000 x (1/0.111427) x [1-{1/(1.11427)^(6)}] - 2460000 = $ 287088.26