Question

Glitter Inc. uses one-quarter common stock and three-quarters debt to finance their operations. The after-tax cost of debt is 7 percent and the cost of equity is 13 percent.
The management of Glitter Inc. is considering an expansion project that costs $1.2 million. The project will produce a cash inflow of $45,000 in the first year and 150,000 in each of the following 10 years (i.e., $150,000 in years 2 through 11.. What is the WACC and should Glitter Inc. invest in this project?

a. 10 percent, no because the NPV is negative

b. 10 percent, yes because the NPV is positive

c. 8.5 percent, no because the NPV is negative

d. 8.5 percent, yes because the NPV is positive

HOW CAN I SOLVE IT BY HAND STEP BY STEP PLEASE

DO NOT USE EXCEL

Answer 1

Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [7.00% x ¾] x [13.00% x ¼]

= [7.00% x 0.75] + [13.00% x 0.25]

= 5.25% + 3.25%

= 8.50%

Net Present Value (NPV) of the Project

Year	Annual Cash Inflow ($)	Present Value factor at 8.50%	Present Value of Annual Cash Inflow ($)
1	45,000	0.921659	41,474.65
2	1,50,000	0.849455	1,27,418.29
3	1,50,000	0.782908	1,17,436.21
4	1,50,000	0.721574	1,08,236.14
5	1,50,000	0.665045	99,756.81
6	1,50,000	0.612945	91,941.76
7	1,50,000	0.564926	84,738.95
8	1,50,000	0.520669	78,100.42
9	1,50,000	0.479880	71,981.95
10	1,50,000	0.442285	66,342.81
11	1,50,000	0.407636	61,145.45
TOTAL			948,573.46

Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment

= $948,573.46 - $1,200,000

= -$251,426.54 (Negative NPV)

DECISION

Therefore, the WACC is 8.50% and Glitter Inc should not invest in this project, since the Net Present Value (NPV) of the Project is -$251,426.54 (Negative NPV).

“Hence, the answer would be (c). 8.5 percent, no because the NPV is negative”

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.