Question

Whright company os considering an investment in new manufacturing equiipment. the equipment cost 220,000 and will provide annual aftertax inflows of $50,000 at the end of each year for 7 years. the firm's market value debt/quity ratio is 25%, its cost of quity is 14%, and it s pretax cost of debt is 7%. the firm's combined marginal fedreal and state tax rate is 40%. Assume the project is of approxinmately the smae risk as the firm's existing operations.

1. What is Kottinger's weighted average cost of capital?

a. 8.91%
b. 9.99%
c. 10.86%
d. 11.14%
e. 12.04%

2. What is the NPV of the proposed project?

a. $6,297
b. $7,899
c. $9,156
d. $13,436
e. $15,984

Answer 1

Kottinger Company

1. Kottinger's weighted average cost of capital is:

= e. 12.04%

2. The NPV of the proposed project is:

b. $7,899

Step-by-step explanation:

a) Data and Calculations:

Cost of new manufacturing equipment = $220,000

Annual after-tax inflows = $50,000

Project period = 7 years

Market value of debt/equity ratio = 25%

Equity ratio = 100%

Firm's total value = 125% (100% + 25%)

Debt market value weight = 25%/125% = 20%

Equity market value weight = 100%/125% = 80%

Cost of equity = 14%

Pretax cost of debt = 7%

Marginal tax rate = 40%

After-tax cost of debt = 0.07 * (1 - 0.40) = 4.2%

Weighted average cost of capital = (0.14 * 0.8) + (0.042 * 0.2)

= 0.112 + 0.0084

= 0.1204

= 12.04%

The present value of $50,000 annual cash inflow for 7 years at 12.04% is:

N (# of periods) 7

I/Y (Interest per year) 12.04

PMT (Periodic Payment) 50000

FV (Future Value) 0

Results

PV of annual cash inflows = $227,898.69

PV of investment = $220,000

NPV = $7,898.69 ($227,898.69 - $220,000)

Sum of all periodic payments $350,000.00

Total Interest $122,101.31