Question

Alpha Industries is considering a project with an initial cost of $8.8 million. The project will produce cash inflows of $1.68 million per year for 8 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.85 percent and a cost of equity of 11.43 percent. The debt–equity ratio is .68 and the tax rate is 40 percent. What is the net present value of the project?

Answer 1

Answer:

Explanation:

After tax cost of debt = 5.85%*(1 - Tax rate)

After tax cost of debt = 5.85%*(1 - 0.4)

After tax cost of debt = 3.51%

Debt-equity ratio = Debt/Equity

Hence, debt = 0.68equity. Let equity be $x. Debt = $0.68x

Total = $1.68x

WACC = Respective costs * Respective weights

WACC = (x/1.68x*11.43%) + (0.68x/1.68x*3.51%)

WACC = 8.224285714%

Present value of annuity= Annuity*[1-(1+interest rate)^-time period] / rate

= $1.68*[1-(1.08224285714)^-8]/0.08224285714

= $1.68*5.698047502

= $9.572719803 million

NPV = Present value of inflows - Present value of outflows

= $9.572719803 million - $8.8 million

= $772,720