Question

DeHass, Inc. is looking at a new investment opportunity that will have an up-front cost of $1,050,000. The company projects that the life of this opportunity will be 6 years. This opportunity will have an annual cost of $30,000 (cash outflow) for upkeep of equipment. This $30,000 cost occurs at the end of each year. DeHass, Inc. expects to generate $300,000 cash inflow at the end of the first year from taking on this potential opportunity. Cash inflows at the end of the second year are expected to be 110% of year one cash inflows. Year 3 cash inflows are expected to be 6% greater than Year 2 cash inflows. Each year after Year 3, the annual increase in cash inflows will be 1% less than it was the year before. So, that means that the Year 4 cash inflows will be 5% greater than the year three cash inflows. You will need to calculate net cash flow amounts for each period in order to answer parts B-D below. The net cash flow for a period is equal to the cash inflows for that period less the cash outflows for that period. The company plans on financing this opportunity 40% with debt and 60% with common stock. The before-tax cost of the debt is 5.75% and the cost of the common stock is 16.5%. The company's marginal tax rate is 35%.

PLEASE INCLUDE EXCEL FUNCTIONS:

(A) What is the weighted average cost of capital (WACC)?

(B) What is the Internal Rate of Return (IRR) of this new opportunity?

(C) What is the Net Present Value (NPV) of this new opportunity?

(D) Should this opportunity be pursued? Why or why not?

Answer 1

[A]	WACC = 5.75%*(1-35%)*40%+16.5%*60% =	11.40%	`
[B]	The cash flows after tax are worked out below:
		0	1	2	3	4	5	6
	Cash inflow generated		300000	330000	349800	367290	381982	393441
	Upkeep of equipment		30000	30000	30000	30000	30000	30000
	Net cash inflow		270000	300000	319800	337290	351982	363441
	Cost of investment	1050000
	Annual net cash inflows	-1050000	270000	300000	319800	337290	351982	363441
	IRR is that discount rate for which NPV=0. It is to be found out by trial and error by trying out different discount rates
	to get 0 NPV.								NPV
	Discounting with 20%--PVIF [PVIF = 1/1.2^n]	1	0.83333	0.69444	0.57870	0.48225	0.40188	0.33490
	PV at 20%	-1050000	225000	208333	185069	162659	141454	121716	-5769
	Discounting with 19%--PVIF	1	0.84034	0.70616	0.59342	0.49867	0.41905	0.35214
	PV at 19%	-1050000	226891	211849	189774	168196	147498	127983	22191
	IRR lies between 19% and 20%. The value of IRR by simple interpolation = 19+22191/(5769+22191) =						19.79%
[C]	PVIF at 11.40% [PVIF = 1/1.114^n]	1	0.89767	0.80580	0.72334	0.64932	0.58287	0.52323
	PV at 11.40%	-1050000	242370	241741	231325	219009	205161	190162	279768
	NPV	$ 2,79,768
[D]	As the NPV of the investment opportunity is positive, it can be pursued.