Question

The firm’s tax rate is 35%. The company has $2,000,000 in annual sales, and annual fixed expenses of $1,100,000 and $500,000 in variable expenses. There was an initial investment in the firm of $1,500,000, which will be depreciated straight-line over 10 years. The project is expected to last 10 years. The firm has a Capital Structure as follows: 1. The market value of the bonds is $2,000,000. 2. The market value of the Preferred Stock is $1,000,000. 3. The market value of the Common stock is $7,000,000 4. The cost of the preferred stock is 4%, the cost of the common stock is 6%, the cost of the bonds is 8%.

1. What is the firm’s WACC? __________________________________Chapter 13

2. What is the firm’s OCF ______________________________________Chapter 9

3. What is the NPV, ___________________________________________Chapter 8

4. Based on your answer to question #3, will to accept or reject this project? What is the reasoning for accepting or rejecting the project? ___________________________________________________________Chapter 8

Answer 1

WACC:
Source	MV	Weights	Cost	Weighted Cost
Debt	2000000	0.2	8%	1.60%
Preferred	1000000	0.1	4%	0.40%
Common	7000000	0.7	6%	4.20%
	10000000	1		6.20%
WACC = 6.20%
Annual Operating CF:
Sales			2000000
Less: variable cost			500000
Less: Fixed cost			1100000
Less: Depreciation (1500000/10)			150000
Before tax net income			250000
Less: Tax @ 35%			87500
After Tax income			162500
Add: Depreication			150000
Annual cashflows			312500
Multiply: Annuity PVF @ 6.20%			7.29085
Present value of Inflowws				2278391
Less: Initial Investment				1500000
NPV				778391
OCF = 312500
NPV = 778391
Accept theh project as NPV is positive