Question

Sisters Ltd is planning to invest in a capital project, which will generate cash inflows of $15,000 in the 1st year, $22,000 in the 2nd year, and $25,000 in the 3rd year. The project ends after year 3. The company’s current debt to equity ratio is 0.8 with the cost of debt of 8% p.a. compounded annually. Sisters Ltd stock has a beta of 1.2. The risk-free rate is 3% p.a. compounded annually and the expected market return is 12% p.a. compounded annually. The cost of equity of 10.5% p.a. compounded annually. The new debt to equity ratio is 1. What is the total present value of the project’s cash inflows? Show your work.

Answer 1

Note: New debt equity ratio has been considered in the calculation of WACC
Source of funds	Cost	Weight	Cost * Weight
Debt	8.00%	0.5	4.00%
Equity	10.50%	0.5	5.25%
Weighted average cost of capital (WACC)	9.25%
Since the debt equity ratio is 1, the new weight of debt = new weight of equity = 1/2 = 0.50
Discount factor = 1/(1+Discount rate)^No. of years
Year	Cash inflow	Discount factor	Discounted cash inflow
	A	B	A*B
1	15000	0.9153	13,729.98
2	22000	0.8378	18,432.31
3	25000	0.7669	19,172.36
Present value of cash inflows			51,334.65