Question

Given the following cash flows:

Year	0	1	2	3
CF	-3,500	600	1,000	Cash flow will grow at a constant rate g=6%

We choose the following capital structure plan:

	Debt	Equity
Plan	30%	70%

Equity Benchmark:

The unlevered beta is 2, tax rate is 40%. Market Return is 16%, risk-free rate is 3%.

Debt Benchmark:

Par:100, Annual Coupon: 6%, 10-year to maturity, Selling at $88.43

What is the NPV of the project?

	a	1728.42
	b	917.53
	c	2231.98
	d	860.42

Answer 1

Levered Beta = 2[1 + (1 - 0.40)(0.30/0.70)]

Levered Beta = 2.514

As per CAPM Model,

Cost of Equity = Rf + Beta(Rm - Rf)

Cost of Equity = 0.03 + 2.514(0.16 - 0.03)

Cost of Equity = 35.69%

Calculating Cost of debt,

Using TVM Calculation,

I = [FV = 100, T = 10, PMT = 6, PV = 88.43]

Cost of Debt = 7.70%

WACC = 0.30(1 - 0.40)(0.077) + 0.70(0.3569)

WACC = 26.37%

So,

Value of Project = -3,500 + 600/(1.2637) + 1,000/(1.2637)² + 1,000(1.06)/(0.2637 - 0.06)(1.2637)²

Value of Project= $860.42