Question

Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for 7 years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is 1.5 percent. The firm has a pre-tax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is .0.65 and the tax rate is 35 percent. What is the net present value of the project

Answer 1

NPV 115,000

Step-by-step explanation:

The first step will be to calcualte the WACC

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

Ke= cost of equity = 0.137

Equity weight 0.35

Kd= cost of debt = 0.086

Debt Weight 0.65

tax rate = 0.35

`WACC = 0.137(0.35) + 0.086(1-0.35)(0.65)`

WACC 8.42850%

Then we adjust by the factor:

8.42850% + 1.5% = 9.9285%

Then we calcualte the present value of the cash flow from the project

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

C 1.54

time 7

rate 0.099285

`1.54 * (1-(1+0.099285)^(-7) )/(0.099285) = PV\\`

PV $7.5150

And last, the NPV which isthe present value of the cashflow less the initial investment

7.515 - 7.4 = 0.115 = 115,000