Question

Suppose ABC firm is considering an investment that would extend the life of one of its facilities for 5 years. The project would require upfront costs of $11.36M plus $23.89M investment in equipment. The equipment will be obsolete in (N+2) years and will be depreciated via straight-line over that period (Assume that the equipment can't be sold). During the next 5 years, ABC expects annual sales of 69M per year from this facility. Material costs and operating expenses are expected to total 42M and 5.49M, respectively, per year. ABC expects no net working capital requirements for the project, and it pays a tax rate of 38%. ABC has 80% of Equity and the remaining is in Debt. If the Cost of Equity and Debt are 19.06% and 6.67% respectively, Should they take the project? (Evaluate the project only for 5 years)

Answer 1

Answer : Calculation of WACC :

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

= [19.06% * 0.80] + [6.67% * (1 - 0.38) * 0.20]

= 16.07508%

Below is the table showing calculation of Net Present value :

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment (11.36 M + 23.89 M)	35.25
Annual Sales Revenue		69	69	69	69	69
Material Cost		42	42	42	42	42
Operating Expenses		5.49	5.49	5.49	5.49	5.49
Less : Depreciation (35.25 / 3)		11.75	11.75	11.75	0	0
Earning before taxes		9.76	9.76	9.76	21.51	21.51
Taxes @ 38%		-3.7088	-3.7088	-3.7088	-8.1738	-8.1738
Earnings After Taxes		6.0512	6.0512	6.0512	13.3362	13.3362
Add : Depreciation		11.75	11.75	11.75	0	0
Operating Cash Flows	35.25	17.8012	17.8012	17.8012	13.3362	13.3362
PV Factor @ 16.07508%	1	0.861511	0.742202	0.639415	0.550864	0.474575
PV of Net Cash flows (Inflow)		15.33594	13.21208	11.38236	7.346426	6.32903
PV of Net Cash flows (Outflow)	35.25
The net present value (NPV) of this project is		= $ 18.35583501M or 18.36 M
NPV = PV of cash inflow - PV of cash outflow
= 53.60583501 - 35.25
= $ 18.35583501M or 18.36M