Question

Alpha Industries is considering a project with an initial cost of $7.9 million. The project will produce cash inflows of $1.63 million per year for 7 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.58 percent and a cost of equity of 11.25 percent. The debt–equity ratio is .59 and the tax rate is 40 percent. What is the net present value of the project?

Answer 1

$494,918

Explanation:

For computation of net present value we need to follow some steps which is shown below:-

After tax cost of debt = Pretax cost of debt × (1 - tax rate)

=5.58% × (1 - 0.4)

= 3.348%

debt ÷ equity

= Debt - equity ratio

Hence debt = 0.59 equity

Assume the equity be $x

Debt = $0.59x

Total = $1.59x

WACC = Respective costs × Respective weights

= (x ÷ 1.59x × 11.25%) + (0.59x ÷ 1.59x × 3.348)

= 8.318%

Present value of annuity = Annuity × (1 - (1 + interest rate)^ - time period] ÷ Rate

=1.63 × [1 - (1.08317811321)^-7]÷ 0.08317811321

= $1.63 × 5.150256501

=$8,394,918.10

Net present value = Present value of cash inflows - Present value of cash outflows

= $8,394,918.10 - $7,900,000

= $494,918