Question

Dyrdek Enterprises has equity with a market value of $10.7 million and the market value of debt is $3.50 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 1.5 percent. The new project will cost $2.18 million today and provide annual cash flows of $571,000 for the next 6 years. The company's cost of equity is 11.03 percent and the pretax cost of debt is 4.87 percent. The tax rate is 39 percent. What is the project's NPV?

Answer 1

Step 1 )

Calculation of Market value weights :'

	Market value	Market value weights
Debt	3.50	3.5 /14.2 = .2465
Equity	10.70	10.7/14.2= .7535
Total	14.2

Step 1)Calculation of Weighted average cost of capital (WACC)

WACC =[Cost of Debt (1-Tax )*weight of Debt ]+[cost of equity *weight of equity]

        =[4.87(1-.39) * .2465 ] +[11.03 * .7535]

        = [4.87* .61 * .2465 ] + 8.3111

        = .7323+ 8.3111

         = 9.04% rounded

Risk adjusted WACC = 9.04 +1.5 = 10.54%

Step 3)

Present value of cash flow = PVA10.54%,6* Cash flow

                   = 4.28720 * 571000

                   = 2,447,991.20

**Find present value annuity factor using financial calculator where i= 10.54% ,n= 6 and PMT =1 Or using the formula [1/(1+i)^1+ 1/(1+i)^2 +.....1/(1+i)^6]

Step 4)

NPV = Present value -Initial cost

        = 2,447,991.20 - 2,180,000

        = 267,991.20