Question

Alpha Industries is considering a project with an initial cost of $8.2 million. The project will produce cash inflows of $1.93 million per year for 6 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.67% and a cost of equity of 11.31%. The debt-equity ratio is 0.62 and the tax rate is 21%. What is the net present value of the project?

Wentworth's Five and Dime Store has a cost of equity of 12.9%. The company has an aftertax cost of debt of 4.2%, and the tax rate is 40%. If the company's debt-equity ratio is 0.6, what is the weighted average cost of capital?

Charlotte's Crochet Shoppe has 14,900 shares of common stock outstanding at a price per share of $77 and a rate of return of 11.69%. The company also has 300 bonds outstanding, with a par value of $2,000 per bond. The pretax cost of debt is 6.17% and the bonds sell for 97.8% of par. What is the firm's WACC if the tax rate is 21%?

Answer 1

Calculation of WACC of the Firm

WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity)

= [5.67% * (1 - 0.21)* (0.62 / 1.62)] + [11.31% * (1 / 1.62)]

= 1.7143% + 6.981481%

= 8.69578148% or 8.70%

Net Present Value is shown below :

Year	Cash Inflow	Present Value Factor @8.69578148%	Present value of cash inflow
1	1.93	0.919998906	1.775597888
2	1.93	0.846397986	1.633548113
3	1.93	0.778685221	1.502862476
4	1.93	0.716389551	1.382631834
5	1.93	0.659077603	1.272019774
6	1.93	0.606350673	1.1702568
		Total Present value of cash inflow	8.736916884
		Less : Cash outflow	8.2
		Net Present Value	0.53692 million or 0.54 million

The above solution has been worked without roeunding off the intermediate digits.

(b.) Calculation of WACC

WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity)

= [4.2% * (0.60 / 1.60)] + [12.9% * (1 / 1.60)]

= 1.575% + 8.0625%

= 9.6375% or 9.64%

(c.) Calculation of WACC :

WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity)

Value of Debt = 300 * 2000 * 97.8% = 586800

Value of Equity = 14900 * 77 = 1,147,300

Total Value = 1,734,100

= [6.17% * (1 - 0.21)* (586800 / 1734100)] + [11.69% * (1147300 / 1734100)]

= 1.65% + 7.73%

= 9.38%