Question

A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1.2, the risk-free rate is 4.6, and the expected market risk premium is 6.1%. The bonds for this company pay interest semiannually and have a coupon interest rate of 6%, 13 years to maturity, a face value of $1,000, and a current price of 922.67. If the corporate tax rate is 36%, what is the NPV of the proposed project for this firm? (Answer to the nearest dollar, but do not use a dollar sign).

  

Years	Cash Flows
0	-5,000
1	2,000
2	3,000

Answer 1

First we need to calculate WACC:

Target Capital structure:

Equity = 60% equity and

Debt = 40%

Cost of equity:

Cost of equity = Risk free rate + Beta * Market risk premium

= 4.6% + 1.2 * 6.1%

= 11.92%

Cost of equity = 11.92%

Cost of debt:

Face value = $1,000

Current price = $922.67

Semiannual coupon = 1000 * 6% / 2 = $30

Time to maturity = 13 years =13* 2 = 26 semiannual periods

To get semiannual cost of debt we will use RATE function

= RATE (nper, pmt, pv, fv, type)

= RATE (26, 30, -922.67, 1000, 0)

= 3.4556%

Before tax cost of debt = 3.4556% * 2 = 6.911%

WACC:

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

= 11.92% * 60% + 6.911% * (1 - 36%) * 40%

= 8.92%

WACC = 8.92%

NPV:

NPV calculations: