Question

DeHass, Inc. is looking at a new investment opportunity that will have an up-front cost of $1,050,000. The company projects that the life of this opportunity will be 6 years. This opportunity will have an annual cost of $30,000 (cash outflow) for upkeep equipment. This $30,000 cost occurs at the end of each year.

DeHass, Inc. expects to generate $300,000 cash inflow at the end of the first year from taking on this potential opportunity. Cash inflows at the end of the second year are expected to be 110% of year one cash inflows. Year 3 cash inflows are expected to be 6% greater than Year 2 cash inflows.

Each year after Year 3, the annual increase in cash inflows will be 1% less than it was the year before. So, that means that the Year 4 cash inflows will be 5% greater than the year three cash inflows.

You will need to calculate net cash flow amounts for each period in order to answer part B-D below. The net cash flow for a period is equal to the cash inflows for that period less the cash outflows for that period.

The company plans on financing this opportunity 40% with debt and 60% with common stock. The before-tax cost of the debt is 5.75% and the cost of the common stock is 16.5%. The company's marginal tax rate is 35%.

(A) What is the weighted average cost of capital (WACC)?

(B) What is the Internal Rate of Return (IRR) of this new opportunity?

(C) What is the Net Present Value (NPV) of this new opportunity?

(D) Should this opportunity be pursued? Why of why not?

PLEASE answer all questions in relation to Excel. Please provide appropriate formulas and functions needed in excel to arrive at your answers.

Answer 1

1) WACC

2) & 3) NPV and IRR

Recommendation - At 11.395% wacc, the company should not pursue this opportunity as it has negative NPV.

Now, I have some doubt regarding depreciation as nothing is mentioned about it. If the above solution is incorrect, try adding the tax savings on depreciation [ computed below ] to the final cash flow from operations and then compute NPV and IRR.

Depreciation per year = $1,050,000 / 6 = $175,000

Tax savings on depreciation = $175000 x 35% = $61,250 [add this amount to cash flow from operations in case above NPV is incorrect].