Question

Exxon-Mobil is thinking about a new project that will be financed with all debt. This project will increase their free cash flows by $100 per year for the next 10 years. The unlevered cost of capital for the project is 15%. The project costs $300 at time 0. Exxon can raise debt with a coupon rate of 5%. The cost of debt (i.e. YTM) is also 5%. Finally, Exxon’s tax rate is 30%. Find the NPV of the project if Exxon takes debt with a maturity of 10 years to finance the project. A. 236.63 B. 286.32 C. 342.24 D. 523.32

Answer 1

Unlevered cost of equity =			10%
Debt amount=			300
Interest amount per year @5% =			15
Tax rate =			30%
Interest tax shield = 15 * 30% =			4.5
Calculation of NPV
			Cash flow	P.V.F. @10%(note1)	Present value of free cash flow
Year 0	Cost of Project		-300	1	-300
Year 1-10	Increase in Free cash flow		100	6.1446	$ 614.46
Year 1-10	Interest tax shield		4.5	6.1446	$    27.65
	NPV				$ 342.11
So, NPV of project is $342 (round off 342.24, Answer C). Project should be accepted.
Note : P.V.F. of year 0 is always 1.
Cum. P.V.F. = {1 - (1/(1+0.10)^10) } / 0.10