You have come across a project which has an initial investment ofINR5 crores. The EBIT expected...

You have come across a project which has an initial investment ofINR5 crores. The EBIT expected from this project is INR 1 crore in perpetuity, a more stable project with more predictability in the cash flows. Project risk is similar to the business risk of the firm’s core operations. The opportunity cost of capital to the firm if it was an all equity financed firm is 14.5%. The tax rate is 30%. Would you choose this project ?

Expert Solution

EBIT = INR 1 crore

t = tax rate = 30%

Operating Cash Flows = EBIT * (1- tax rate) = INR 1 crore * (1 - 30%) = INR 0.7 crore

r = Cost of capital of firm = 14.5%

Present value of cash flows = Operating Cash flow per year / Cost of Capital

= INR 0.7 crore / 14.5%

= INR 4.8275862069 crore

= INR 4.83 crores

Net Present Value of the Project = Present Value of Cash Flows - Initial Investment

= INR 4.83 crores - INR 5 crores

= -INR 0.17 crores

Therefore, NPV of the Project is (-0.17 crores)

Project should not be selected since NPV of the Project is negative

jeff jeffy answered 2 years ago

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