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In: Finance

Suppose that Caterpillar Incorporated is considering a new line of construction graders. To launch the new...

Suppose that Caterpillar Incorporated is considering a new line of construction graders. To launch the new product, Caterpillar will have to invest $200.00 million. The target capital structure for Caterpillar is 45.00% debt and 55.00% equity (market values).

The CFO for the company believes that new debt can be issued with an 8.00% annual coupon rate. After reviewing the company’s beta, the CFO also believes that common stockholders require a 15.00% return for the new investment.

The company projects an annual after-tax cash flow of $65.00 million for the new project. The company has a marginal tax rate of 35.00%, and expects to run the project for 10.00 years.

What is the NPV for the project?(express in millions)

Solutions

Expert Solution

Net present value is equal to present value of cash inflow less present value of cash outflow
Calculation of Weighted average cost of capital to be used at discount rate to calculate NPV
After tax cost of debt is 8%*(1-0.35) 5.20%
WACC Weight of equity*Cost of equity + Weight of debt*Cost of debt
WACC (0.55*0.15)+(0.45*0.052)
WACC 10.59%
Calculation of net present value
Year Cash flow Discount factor @ 10.59% Present Value (Cash inflow*Discount factor)
0 -200 1.00000 1/(1.1059^0) -200.000
1 65 0.90424 1/(1.1059^1) 58.776
2 65 0.81765 1/(1.1059^2) 53.147
3 65 0.73935 1/(1.1059^3) 48.058
4 65 0.66855 1/(1.1059^4) 43.456
5 65 0.60453 1/(1.1059^5) 39.295
6 65 0.54664 1/(1.1059^6) 35.532
7 65 0.49430 1/(1.1059^7) 32.129
8 65 0.44696 1/(1.1059^8) 29.053
9 65 0.40416 1/(1.1059^9) 26.271
10 65 0.36546 1/(1.1059^10) 23.755
NPV 189.471
The net present value of the project is $189.471 million

jeff jeffy answered 9 months ago
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