Question

Norris Co. has developed an improved version of its most popular product. To get this improvement to the market, will cost $48 million and will return an additional $13.5 million for 5 years in net cash flows. The firm’s debt-equity ratio is .25, the cost of equity is 13 percent, the pretax cost of debt is 9 percent, and the tax rate is 30 percent. What is the net present value of this proposed project?

A) $989,760

B) $1,102,459

C) $1,214,318

D) $1,077,180

E) $1,306,411

Answer 1

After tax cost of debt = 9% (1-.3) = 6.3%

Cost of capital = (Weight of debt * after tax cost of debt) + (Weight of equity * cost of equity)

= (.25/1.25 * 6.3%) + (1/1.25 * 13%)

= 1.26% + 10.4% = 11.66%

			Amt in $
Year	Cash Flows	PV Factor @ 11.66%	Present value
0	-48000000	1	-48000000
1	13500000	0.8956	12090274.05
2	13500000	0.8021	10827757.52
3	13500000	0.7183	9697078.20
4	13500000	0.6433	8684469.10
5	13500000	0.5761	7777600.85
NPV			1077179.72

NPV is D) $1,077,180