Alpha Industries is considering a project with an initial cost of $8.2 million. The project will...

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 40%. What is the net present value of the project?

Hint: You'll need to calculate the appropriate discount rate and use it to calculate the NPV. Be careful not to confuse debt-equity ratios with debt-value ratios.

Solutions

Expert Solution

Cost of debt after-tax=5.67*(1-tax rate)

=5.67*(1-0.4)

=3.402%

Debt-equity ratio=debt/equity

Hence debt=0.62*equity

Let equity be $x

Debt=0.62x

Total=1.62x

WACC=Respective cost*Respective weight

=(x/1.62x*11.31)+(0.62x/1.62x*3.402)

=8.28348148%(Approx)

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=1.93/1.0828348148+1.93/1.0828348148^2+1.93/1.0828348148^3+1.93/1.0828348148^4+1.93/1.0828348148^5+1.93/1.0828348148^6

=$8.85 million

NPV=Present value of inflows-Present value of outflows

=8.85-8.2

=$0.65 million(Approx)

ekkarill92 answered 1 year ago

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