Question

Dyrdek Enterprises has equity with a market value of $12.7 million and the market value of debt is $4.50 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 2.2 percent. The new project will cost $2.58 million today and provide annual cash flows of $671,000 for the next 6 years. The company's cost of equity is 11.83 percent and the pretax cost of debt is 5.07 percent. The tax rate is 35 percent. What is the project's NPV? rev: 10_31_2018_QC_CS-146160 Multiple Choice $377,207 $579,510 $192,088 $194,678 $158,451

Answer 1

Answer: First we will have to calculate the WACC of the project

WACC = Weight of equity * cost of equity + weight of debt * cost of debt * ( 1 - tax rate)

weight of equity = 12.7/(12.7 + 4.5)

Weight of debt = 4.5/(12.7 +4.5)

Cost of equity = 11.83%

Cost of debt = 5.07 %

Putting the values in the equation

WACC = 0.7383 * 11.83% + 0.2616 * 5.07% (1-0.35)

WACC = 8.7% + 0.9%

WACC = 9.6%

Project return = 9.6% + risk adjustment factor

Project return = 9.6% +2.2 %

Project return = 11.7971%

Present value formula = cash flow/(1+ discount rate )^(no of year)

year	0	1	2	3	4	5	6
Initial investment	-2,580,000
Cash flow	-2,580,000	671000	671000	671000	671000	671000	671000
Present value (cash flow/(1+ 0.1179)^(no of years)	-2580000	600194.5	536860.5	480209.7	429536.8	384211	343668.2
Net present value (Sum of all present values)	194680.6

NPV of the project is 194680 close to 194678 is the answer.