Question

Orchard Farms has a pre-tax cost of debt of 7.68 percent and a cost of equity of 15.2 percent. The firm uses the subjective approach to determine project discount rates. Currently, the firm is considering a project to which it has assigned an adjustment factor of -0.5 percent. The firm's tax rate is 34 percent and its debt-equity ratio is 0.45. The project has an initial cost of $4.3 million and provides cash inflows of $1.27 million a year for 5 years. What is the net present value of the project

Answer 1

NPV of the project 497,000

Step-by-step explanation:

First, we calcualte the WACC for the firm

`WACC = K_e((E)/(E+D)) + K_d(1-t)((D)/(E+D))`

Ke= cost of capital= 0.152

Equity weight 0.55

Kd= cost of debt= 0.0768

Debt Weight 0.45

tax rate= 0.34

`WACC = 0.152(0.55) + 0.0768(1-0.34)(0.45)`

WACC 10.64096%

Then, we adjust for the proposed factor: (-0.5 percent)

10.64096% - 0.5% = 10.14096% This will be the project rate.

Now, we calcualte the NPV

The present value of the cash inflows:

`C * (1-(1+r)^(-time) )/(rate) = PV\\`

C 1.27

time 5

rate 0.1014096

`1.27 * (1-(1+0.1014096)^(-5) )/(0.1014096) = PV\\`

PV $4.7970

NPV = 4.797 millions - 4.3 millions = 0.497 millions = $497,000