Question

Beta Industries is considering a project with an initial cost of $6.9 million. The project will produce cash inflows of $1.52 million a year for seven years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is +2.2 percent. The firm has a pretax cost of debt of 9.1 percent and a cost of equity of 17.7 percent. The debt-equity ratio is 2.67 and the tax rate is 34 percent. What is the net present value of the project? (Round the answer to the nearest $100.)

Answer 1

Answer:

The net present value of the project is $173,200

Explanation:

According to the given data we have the following:

Let Weight of debt = Wd = x

Weight of equity = We = 1-x

Debt / equity = 2.67

x / (1-x) = 2.67

3.67x = 2.67

Weight of Debt = Wd = x = 0.72752

Weight of Equity = We = (1-x) = 1-0.72752 = 0.27248

Cost of debt = rd = 9.1%

Cost of equity = re = 17.7%

Tax rate = t = 34%

Therefore, WACC = [Wd * rd * (1-t)] + [We*re]

= [0.72752 * 9.1%*(1-34%)] + [0.27248 * 17.7%]

= 4.36949% + 4.82290%

= 9.19239%

Hence, Discount rate for the project = 9.19%+2.2% = 11.39%

The net present value of the project is $173,200