Question

Alpha Industries is considering a project with an initial cost of $8.4 million. The project will produce cash inflows of $1.56 million per year for 8 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.49 percent and a cost of equity of 11.19 percent. The debt–equity ratio is .56 and the tax rate is 40 percent. What is the net present value of the project?

$400,549

$445,055

$462,857

$188,348

$381,475

Answer 1

After-tax cost of debt=5.49*(1-tax rate)

=5.49*(1-0.4)=3.294%

Debt-equity ratio=debt/equity

Hence debt=0.56 equity

Let equity be $x

Debt=$0.56 x

Total=$1.56 x

WACC=Respective costs*Respective weight

=(x/1.56x*11.19)+(0.56x/1.56x*3.294)

=8.355538462%

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate
=1.56[1-(1.08355538462)^-8]/0.08355538462

=$1.56*5.669906799

=$8,845,054.61 million(Approx)

NPV=Present value of inflows-Present value of outflows

=$8,845,054.61-$8,400,000

=$445,055(Approx).