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?
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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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