The following 5-year project requires equipment that costs $100,000. If undertaken, the shareholders will contribute $25,000 cash and borrow $75,000 with an interest-only loan with a maturity of 5 years and annual interest payments. The equipment will be depreciated straight-line to zero over the 5-year life of the project. There will be a pre-tax salvage value of $5,000. There are no other start-up costs at year 0. During years 1 through 5, the firm will sell 25,000 units of product at $5; variable costs are $3; there are no fixed costs. i = rdebt = 10% and Tax rate = 34%
What is the NPV of the project using the WACC methodology? (Proper order of execution: get the WACC first, then get the OCF, then calculate the PV of the OCFs and add up to get the NPV)
Capital | 25000 | |
Debt | 75000 | |
Equity-debt ratio | 25:75 | |
Cost of capital | 10 | 2.5 |
Cost of debt (after tax) | 6.6 | 4.95 |
Total cost of capital (WACC) | 7.45 |
T0 | T1 | T2 | T3 | T4 | T5 | |
Equipment cost | -100000 | |||||
Interest on debt after tax | -4950 | -4950 | -4950 | -4950 | -4950 | |
Depreciation tax saving | 6800 | 6800 | 6800 | 6800 | 6800 | |
Sale of equipment after tax | 3300 | |||||
Profit on sales after tax | 33000 | 33000 | 33000 | 33000 | 33000 | |
Net PV | -100000 | 34850 | 34850 | 34850 | 34850 | 38150 |
PV for WACC | 1 | 0.930665 | 0.866138 | 0.806085 | 0.750195 | 0.698181 |
NPV | -100000 | 32434 | 30185 | 28092 | 26144 | 26636 |
Total NPV | 43491 | |||||
Sale units | 25000 | |||||
Sale price | 5 | |||||
Variable cost | 3 | |||||
Profit per unit | 2 |
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