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Question 5: XYZ Company has sales of $4,800,000, COGS is 40% of sales, operating expenses are...

Question 5: XYZ Company has sales of $4,800,000, COGS is 40% of sales, operating expenses are $2,100,000, interest expense $20,000 and depreciation 30,000. Tax rate 40%. Construct their income statement and answer the below. They have a 50-50 target capital structure of debt/equity. Their stated bank loan rate is 6% and rs = 12%. WACC is 7.8%.

If the cost of capital for this project is determined to be equal to their WACC (reference question #5) instead, what is the NPV?

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Expert Solution

Sales = $4,800,000

Less: COGS ($4,800,000*40%) = $1,920,000

Less: Operating Expense = $2,100,000

Profit before Interest,tax & Depreciation = $7,80,000

Less: Depreciation = $30,000

Profit Before Interest and tax = $7,50,000

Less: Interest = $20,000

Profit Before tax = $7,30,000

Less: Tax($7,30,000*40%) = $2,92,000

Profit After Tax = $4,38,000

Add: Depreciation(Non-cash Item) = $30,000

Net Profit = $ 4,68,000

When the new projects are of similar risk like existing projects of the company, it is an appropriate benchmark rate to decide the acceptance or rejection of these projects.

The weighted average cost of capital -- WACC -- is a company's weighted average cost of equity and cost of debt. The cost of equity is the risk-free rate plus a risk premium. The cost of debt is equal to the tax-adjusted yield of a long-term bond held to maturity. An investment's net present value -- NPV -- is the discounted present value of its future cash flow stream using the weighted average cost of capital as the discount rate. The cost of debt is zero for companies with no debt. In that case, the discount rate is equal to the cost of equity.

Cost of capital refers to the opportunity cost of making a specific investment. It is therate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, the cost of capital is the rate of return required to persuade the investor to make a given investment.

jeff jeffy answered 2 years ago
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