Question

CrochetCo is considering an investment in a project which would require an initial outlay of $302774 and produce expected cash flows in years 1 through 5 of $89756 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows:

Source of Capital |
Cost |
Weight |

Long-Term Debt |
4% |
59% |

Preferred Stock |
10% |
18% |

Common Stock |
14% |
23% |

What is the net present value of this project?

Answer #1

Calculation of firm's
required rate of return |
|||

Source of capital |
Cost |
Weight |
Cost*Weight |

Long term debt | 4 | 0.59 | 2.36 |

Preferred stock | 10 | 0.18 | 1.80 |

Common stock | 14 | 0.23 | 3.22 |

Total |
7.38 |
||

Firm's cost of capital= Weighted average |
|||

7.38% |
(See table) |
||

Calculation of
NPV |
|||

Year |
Cashflow ($) |
Discounting factor @ 7.38% |
PV of cashflows ($) |

0 | -302774 | 1 | -302774.00 |

1 | 89756 | 0.931272118 | 83587.26 |

2 | 89756 | 0.867267757 | 77842.48 |

3 | 89756 | 0.807662281 | 72492.54 |

4 | 89756 | 0.752153363 | 67510.28 |

5 | 89756 | 0.700459455 | 62870.44 |

NPV |
61529.00 |
||

We know, | |||

NPV= Present value of future cashflows from the project
discounted at the required rate of return |
|||

$61,529 |
(rounded off to two decimal places) |

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