Question

Alpha Industries is considering a project with an initial cost of $7.7 million. The project will produce cash inflows of $1.35 million per year for 9 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.52 percent and a cost of equity of 11.21 percent. The debt–equity ratio is .57 and the tax rate is 35 percent. What is the net present value of the project? A) $346,351 B) $497,319 C) $522,185 D) $580,205 E) $603,414

Answer 1

After-tax cost of debt=5.52*(1-tax rate)

=5.52*(1-0.35)=3.588%

Debt-equity ratio=debt/equity

Hence debt=0.57 equity

Let equity be $x

Debt=$0.57 x

Total=$1.57x

WACC=Respective costs*Respective weight

=(x/1.57x*11.21)+(0.57x/1.57x*3.588)

=8.44277707%

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

=$1.35[1-(1.0844277707)^-9]/0.0844277707

=$1.35*6.133485512

=$8,280,205.44

NPV=Present value of inflows-Present value of outflows

=$8,280,205.44-$7,700,000

=$580205(Approx).