Question

Logic Co. has the following information:

Debt outstanding: $280 million
Before-tax cost of debt: 5%
Market cap: $650 million
Cost of common stock: 11%
Tax rate: 21%

Logic is evaluating a project with the following information:

Over the next five years EBIT will equal: 12 million, 13 million, 14 million, 15 million, 16 million respectively.
An investment of $5 million is required in net working capital at the beginning of the project, which will be recovered at the end of the project.
The cost of the equipment will be $30 million depreciated using straight-line to zero over the project's life, with no salvage value.
The project requires an additional 1% risk premium above the firms WACC.

1.     Calculate the WACC for the firm. (Enter percentages as decimals and round to 4 decimals)

2.    Calculate the operating cash flows for the first year of the project.

3.    Calculate the net present value for the project. (Round to 2 decimals)

Answer 1

1
Calculate WACC for project
WACC	Weight of equity*Cost of equity + (Weight of debt*Cost of debt*(1-tax rate))
Weight of equity	69.89%	650/(280+650)
Weight of debt	30.11%	280/(280+650)
WACC	(69.89%*11%)+(30.11%*5%*(1-0.21))
WACC	8.8772%
2
Operating cash flow in year 1
EBIT	$12.00	million
Taxes @ 21%	$2.52	million
Net income	$9.48	million
Add: Depreciation	$6.00	(30/5)
Operating cash flow	$15.48	million
3
Calculate net present value
Year	0	1	2	3	4	5
EBIT		$12.00	$13.00	$14.00	$15.00	$16.00
Taxes @ 21%		$2.52	$2.73	$2.94	$3.15	$3.36
Net income		$9.48	$10.27	$11.06	$11.85	$12.64
Add: Depreciation		$6.00	$6.00	$6.00	$6.00	$6.00
Operating cash flow		$15.48	$16.27	$17.06	$17.85	$18.64
Purchase of equipment	-$30.00
NWC	-$5.00
Recovery of NWC						$5.00
Net cash flow	-$35.00	$15.48	$16.27	$17.06	$17.85	$23.64
Discount factor @ 9.8772%	1.00000	0.91011	0.82829	0.75384	0.68607	0.62440
Present value	-$35.00	$14.09	$13.48	$12.86	$12.25	$14.76
Net present value	$32.43
Thus, net present value is $32.43 million