Question

CrochetCo is considering an investment in a project which would require an initial outlay of $350,000 and produce expected cash flows in years 1-5 of $95,450 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows:Cost of Long-Term Debt7%Cost of Preferred Stock11%Cost of CommonStock15%Long-term debt currently makes up 25% of the capital structure, preferred stock 15%, and common stock 60%. What is the net present value of this project?A) -$9,306B) $2,149C) $5,983D) $11,568

Answer 1

Answer:

Ans. A) NPV= -$9306

Explanation:

Hi, the first thing we need to do is to find the after-tax cost of the firm's capital, and since all capital sources are expressed in terms of after-tax percentage, we just multiply each proportion of capital by its costs, I mean

Long term Debt (7%) * 25% +Preffered Stock(11%)*15% + Common Stock(15%)*60%

The answer to this is 12.40%.

Now, we can find the net present value of this project by using the following formula.

$NPV=-InitialOutlay+\frac{CashFlow((1+Cost of Capital)^{n} -1)}{Cost of Capital(1+Cost of Capital)^{n}}$

$NPV=-350,000+\frac{95,450((1+0.124)^{5} -1)}{0.124(1+0.124)^{5}} =-9,306.5$

Since the expected cash flow takes place 5 times form year 1 to 5, and is equal to $95,450, "n" is equals to 5 and "CashFlow" is equal to $95,450.

Therefore, the NPV of this project is -$9,306, which is answer A)

Best of luck.