Question

A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1.3, the risk-free rate is 4.6, and the expected market risk premium is 5.5%. The bonds for this company pay interest semiannually and have a coupon interest rate of 6%, 17 years to maturity, a face value of $1,000, and a current price of 1,099.48. If the corporate tax rate is 30%, what is the NPV of the proposed project for this firm? (Answer to the nearest dollar, but do not use a dollar sign). Years Cash Flows 0 -4,000 1 2,000 2 3,000

Answer 1

Generally cash flows discounted at WACC .

Calculation of The WACC:-

Cost of equity = Rf + beta * market risk premium = 4.6% + 1.3 * 5.5%

Cost of equity = 11.75%

Cost of debt before tax =[ I + (F- NP) /n ] / (F +NP) /2

I =annual interest payment = 1000*6% = 60

F = face value = 1000

NP =net proceeds = 1099.48

n = years to maturity = 17 years

=[ 60 +( 1000 - 1099.48) / 17] / (1000+1099.48)/2

= [ 60 - 5.85176471] / 1049.74 = 0.05158252

Cost of debt before tax = 5.158252%

Cost of debt after tax = cost of debt before tax *(1-tax rate)

= 5.158252% * ( 1 - 0.30) = 3.61078%

WACC = cost of debt after tax * weight of debt +cost of equity "weight of equity

WACC = 3.61078% * 0.40 + 11.75% * 0.60= 8.4943%

WACC = 8.49%

Calculation of NPV :-

Calculation of present value of cash inflows.

Years	cash flows	[email protected]%	Present value of CF
1	2000	0.9217	1843.4
2	3000	0.8496	2,548.8
Present valueof cash inflows	$ 4,392.2

NPV = present value of cash inflows - initial investment

NPV = $ 4,392.2 - $ 4,000 = $ 392.2