Question

Dyrdek Enterprises has equity with a market value of $11.6 million and the market value of debt is $3.95 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 2.2 percent. The new project will cost $2.36 million today and provide annual cash flows of $616,000 for the next 6 years. The company's cost of equity is 11.39 percent and the pretax cost of debt is 4.96 percent. The tax rate is 39 percent. What is the project's NPV?

$175,739

$570,280

$211,451

Answer 1

Market value of equity = 11,600,000

Market value of debt = 3,950,000

Total market value = 11,600,000 + 3,950,000 = 15,550,000

weight of equity = 11,600,000 / 15,550,000 = 0.746

weight of debt = 3,950,000 / 15,550,000 = 0.254

Pre tax cost of debt = 4.96%

After tax cost of debt = 0.0496 ( 1 -0.39)

After tax cost of debt = 0.030256 or 3.0256%

WACC = 0.746 * 0.1139 + 0.254 * 0.030256

WACC = 0.084969 + 0.007685

WACC = 0.09265 or 9.265%

Sinc the project is riskier, WACC oof project = 9.265 + 2.2 = 11.465%

NPV = present value of cash inflows - present value of cash outflows

NPV = -2,360,000 + 616,000 / ( 1 + 0.11465)¹ + 616,000 / ( 1 + 0.11465)² + 616,000 / ( 1 + 0.11465)³ + 616,000 / ( 1 + 0.11465)⁴ + 616,000 / ( 1 + 0.11465)⁵ + 616,000 / ( 1 + 0.11465)⁶

NPV = $211,451