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Alpha Industries is considering a project with an initial cost of $9.1 million. The project will...

Alpha Industries is considering a project with an initial cost of $9.1 million. The project will produce cash inflows of $2.13 million per year for 6 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 6.15 percent and a cost of equity of 11.63 percent. The debt–equity ratio is .78 and the tax rate is 35 percent. What is the net present value of the project?

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Answer #1

After-tax cost of debt=6.15*(1-tax rate)

=6.15*(1-0.35)=3.9975%

Debt-equity ratio=debt/equity

Hence debt=0.78 equity

Let equity be $x

Debt=$0.78x

Total=$1.78x

WACC=Respective costs*Respective weight

=(x/1.78x*11.63)+(0.78x/1.78x*3.9975)

=8.285421348%

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

=$2.13[1-(1.08285421348)^-6]/0.08285421348

=$2.13*4.583122739

=$9.76 million

NPV=Present value of inflows-Present value of outflows

=$9.76 million-$9.1 million

=$0.66 million(Approx).

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