Question
In: Finance
Roger has a levered cost of equity of 0.15. He is thinking of investing in a...
Roger has a levered cost of equity of 0.15. He is thinking of investing in a project with upfront costs of $9 million, which pays $3 million per year for the next 7 years. He is going to borrow $1 million to offset the startup costs at a rate of 0.05. His tax rate is 0.4. He will repay this loan at the end of the project. What is the NPV of this project, using the FTE method?
Solutions
Expert Solution
|
Given, Cost of the equity(CE) =
0.15 Cost of the Debt(CD) = 0.05 Tax Rate = 40% Total cost for the project is $ 9 Million. Of these, $ 1 Million is funded with borrowed funds and $ 8 Million is funded with Own funds. Annual cash inflow is $ 3 Million. Annual interest Payment is $ 1 Million * 0.05 = $50000. Interest payment of $50000 is eligible for tax deduction Weighted average cost of capital = CD*(1-Tax rate)*Debt funds/Total funds + CE * Own funds/ total funds = 0.05*(1-0.4)*$1M/$9M + 0.15*$8M/$9M = 0.0033 + 0.1333 = 0.1366 (or) 13.66% |
| Calculation of Net Present Value of the Project | ||||||||
| Year | Particulars | A | B | (C=A-B) | D | E=C-D | F | E*F |
| Cash Inflow/(Outflow) | Interest Paid | Net Cash Inflow(A-B) | Tax Paid @ 40% | Net cash flow after tax | Present Value annuity Factory @ 13.66 | PV of cash flow | ||
| 0 | Intial Cash outflow | -$ 90,00,000 | - | -$ 90,00,000 | - | -$ 90,00,000 | 1.0000 | -$ 90,00,000 |
| 1 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.8798 | $ 15,57,276 |
| 2 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.7741 | $ 13,70,118 |
| 3 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.6810 | $ 12,05,453 |
| 4 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.5992 | $ 10,60,578 |
| 5 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.5272 | $ 9,33,115 |
| 6 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.4638 | $ 8,20,970 |
| 7 | Cash inflow | $ 30,00,000 | $ 50,000 | $ 29,50,000 | $ 11,80,000 | $ 17,70,000 | 0.4081 | $ 7,22,303 |
| 7 | Loan repayment | -$ 10,00,000 | - | -$ 10,00,000 | - | -$ 10,00,000 | 0.4081 | -$ 4,08,081 |
| Net Present Value | -$ 17,38,268 |
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