Question

Alpha Industries is considering a project with an initial cost of $9.7 million. The project will produce cash inflows of $1.67 million per year for 9 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 6.12 percent and a cost of equity of 11.61 percent. The debt–equity ratio is .77 and the tax rate is 40 percent. What is the net present value of the project?

Answer 1

After-tax cost of debt=6.12*(1-tax rate)

=6.12*(1-0.4)=3.672%

Debt-equity ratio=Debt/equity

Hence debt=0.77 equity

Let equity be $x

Debt=$0.77x

Total=$1.77x

WACC=Respective costs*Respective weight

=(x/1.77x*11.61)+(0.77x/1.77x*3.672)

=8.156745763%

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=1.67[1-(1.08156745763)^-9]/0.08156745763

=$1.67*6.206374532

=$10.36 million

NPV=Present value of inflows-Present value of outflows

=$10.36 million-$9.7 million

=$0.66 million(Approx).