Question

14.

Following is project A's cash flow table

Year	Cash Flow
0	-26,000
1	6,200
2	6,200
3	6,200
4	6,200
5	9,700

Assuming that the project is found by 40% of equity and 60% of debt. The required rate of return of equity is 10%. The yield of debt is 6% and the tax rate is 30%.

Using the above information to answer Q1 - Q4.

Q1) What is the WACC of this project?

		a)6.52%
		b)4%
		c)7.43%
		d)5%

Q2) What is the NPV of this project?

		a) 2303.50
		b) 2823.21
		c) 2795.86
		d) 2187.62

Q3) What is the IRR of this project?

		a) 10.27%
		b) 9.54%
		c) 8.78%
		d) 9.23%

Q4) Should we invest in this project?

		a) No, because the project payback year is too long
		b) No, because the IRR is too low
		c) Yes, because the project NPV is greater than 0
		d) Not sure

Answer 1

1

Weight of equity = 1-D/A

Weight of equity = 1-0.6

W(E)=0.4

Weight of debt = D/A

Weight of debt = 0.6

W(D)=0.6

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 6*(1-0.3)

= 4.2

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.2*0.6+10*0.4

WACC =6.52%

2

Project
Discount rate	6.520%
Year	0	1	2	3	4	5
Cash flow stream	-26000	6200	6200	6200	6200	9700
Discounting factor	1.000	1.065	1.135	1.209	1.287	1.371
Discounted cash flows project	-26000.000	5820.503	5464.235	5129.774	4815.785	7073.200
NPV = Sum of discounted cash flows
NPV Project =	2303.50
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

3

IRR is the rate at which NPV =0
IRR	9.54%
Year	0	1	2	3	4	5
Cash flow stream	-26000.000	6200.000	6200.000	6200.000	6200.000	9700.000
Discounting factor	1.000	1.095	1.200	1.314	1.440	1.577
Discounted cash flows project	-26000.000	5659.965	5166.968	4716.913	4306.058	6150.097
NPV = Sum of discounted cash flows
NPV Project =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	9.54%

4