Question

And all equity finance project involves an investment of 40 million. It will generate a constant perpetuity of 20 million in revenue in the constant perpetuity of 10 million in cost be getting one year from today if the tax rate is 35% then...

A. The project will be accepted if the payback criterion is 6 years or less

B. The project will be accepted under an NPV rule with a cost of capital is 16%

C. The project will be accepted if the payback criterion is 7 years or less

D. The project will be accepted under an NPV rule with a cost of capital of 12%

E. Answers C and D are correct

F. Answers A and B are correct

G. None of the above are correct

Answer 1

Initial Investment - 40,000,000

Net Cash flow = (Revenue - Cost)*(1-Taxes)

= (20,000,000 -10,000,000)* (1-35%)

= 10,000,000 * 0.65

= $ 65,00,000 (6.5 Million)

Payback Period in Equal cash flow = Initial investment / Annual cash flows

Payback period = 40,000,000 / 65,00,000

= 6.15 Years

Payback period of the project is 6.15 years, Therefore, The project will be accepted if the payback criterion is 7 years or less while it will not be accepted if the criteria is less than 6 years.

Option B Evaluation: If the cost of capital is 16%, NPV is

Net Present Value = Present Value of future cash flows - Intitial invetsment

To caclaulate present value of cash flow in perpetuity we use formulae

Perpetuity = Annual cash flow / cost of capital

= 65,00,000 / 16%

= 40,625,000

Net present value = 40,625,000 - 40,000,000

= $625000 (project should be accepted if cost of capital is 16%)

Option D Evaluation

Present value of cash flows = 65,00,000 /12%

= 54166666.67

Net Present Value = Present Value of future cash flows - Intitial invetsment

= 54166666.67 - 40,000,000

= $14166666.67 (Project should be accepted if cost of capital is less than 12%)

Therefore, Option G is Correct because Options B,C,D are correct while A is wrong