Question

A 10-yr project has an initial cost of $300,000 for fixed assets. The fixed assets will be depreciated to a $0 book value using a 20-yr straight line depreciation method.

Each year, annual revenue is $30,000 and cost is $10,000.

After 10 years, you will terminate the project. You expect to sell the the fixed assets for $200,000.

The project is financed by 30% equity and 70% debt. The required rate of return on equity is 7% and the borrowing cost is 3%.

Assume the tax rate is 25%.

What is the project's NPV?

Group of answer choices

-14,735

5,027

11,405

25,229

Answer 1

Annual depreciation = 300,000 / 20 = 15,000

operating cash flow from year 1 to year 5 = (Revenue - costs - depreciation)(1 - tax) + depreciation

operating cash flow from year 1 to year 5 = (30,000 - 10,000 - 15,000)(1 - 0.25) + 15,000

operating cash flow from year 1 to year 5 = 3,750 + 15,000

operating cash flow from year 1 to year 5 = 18,750

Book value after 10 years = 15,000 * 10 = 150,000

Year 10 non operating cash flow = Market value - tax(market value - book value)

Year 10 non operating cash flow = 200,000 - .25(200,000 - 150,000)

Year 10 non operating cash flow = 200,000 - 12,500

Year 10 non operating cash flow = 187,500

WACC = Weights * costs

WACC =0.3*0.07 + 0.7*0.03*(1 - 0.25)

WACC = 0.021 + 0.01575

WACC = 0.03675 or 3.675%

NPV = Present value of cash inflows - present value of cash outflows

NPV = Annuity * [1 - 1 / (1 + r)ⁿ] / r + FV/ (1 +r)ⁿ - Initial investment

NPV = 18,750 * [1 - 1 / (1 + 0.03675)¹⁰] / 0.03675 + 187,500/ (1 +0.03675)¹⁰ - 300,000

NPV = 18,750 * [1 - 0.697043] / 0.03675 + 130,695.5593 - 300,000

NPV = 18,750 * 8.243728 + 130,695.5593 - 300,000

NPV = -$14,735