Question

Ramblin Wreck is a firm specializing in engineering components. The firm is publicly traded and is considering the following project:

The project will last 5.00 years with an annual cash flow of $40.00 million. The project will require an initial investment of $140.00 million

The firm must determine the cost of capital to evaluate the project. (The project is within the firm’s normal activities)

Ramblin Wreck, Inc. Financial Data:

STOCK DATA:		BOND DATA:
Current Price Per Share	$29.00	Current Price Per Bond	$936.00
# of Shares	2.00 million	# of bonds	20,000.00
Book Value	$50 million	Annual Coupon Rate	8.00%
		Face Value Per Bond	$1,000
		Maturity	10 years

The risk free rate in the economy is currently 2.00%, while investors have a market risk premium of 8.00%. Ramblin Wreck, Inc. has a beta of 1.42. The tax rate is 36.00%.

a) What is the WACC for the project?

b) What is the NPV of the project? (express in millions, so 1000000 would be 1.00)

Answer 1

a

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

After tax cost of debt = 9*(1-0.36)

= 5.76

Weight of equity = 1-D/A

Weight of equity = 1-0.244

W(E)=0.756

Weight of debt = D/A

Weight of debt = 0.244

W(D)=0.244

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=5.76*0.244+13.36*0.756

WACC% = 11.51

b

Discount rate	11.510%
Year	0	1	2	3	4	5
Cash flow stream	-140	40	40	40	40	40
Discounting factor	1.000	1.115	1.243	1.387	1.546	1.724
Discounted cash flows project	-140.000	35.871	32.169	28.848	25.870	23.200
NPV = Sum of discounted cash flows
NPV Project =	5.96
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor