Question

A levered firm has a target capital structure of 30 percent debt and 70 percent equity. The aftertax cost of debt is 5.1 percent, the tax rate is 35 percent, and the cost of equity is 13.1 percent. The firm is considering a project that is equally as risky as the overall firm. The project has an initial cash outflow of $1.2 million and annual cash inflows of $516,000 at the end of each year for 3 years. What is the NPV of the project?

Multiple Choice

$64,001.03

$69,856.82

$67,565.33

$60,174.68

$93,322.15

Answer 1

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity

= [After Tax Cost of Debt * Weight of Debt ] + (Cost of Equity * Weight of Equity )

= [ 5.1% * 30% ] + ( 13.1% * 70%)

= 10.7%

Net Present Value = Present Value of Cash Inflows -Present Value of Cash Outflows

= [ $ 516,000 * 1/( 1.107) ^ 1 + $ 516,000 * 1/( 1.107) ^ 2 + $ 516,000 * 1/( 1.107) ^ 3 ] - $ 1,200,000

= $ 1,267,565.33 - $ 1,200,000

= $ 67,565.33

Hence the correct answer is $ 67,565.33