Question

3. A publicly-traded company is planning a $2M expansion. The expansion is projected to produce an ann cash flow of $1,500,000 for the next two years (beginning one year from today). The expansion will be financed by selling $20M in new debt and $30M in common stock. The firm's coupon rate of interesti and the YTM on the firm's bonds is 9%. The firm's cost of equity is 14% and the firm is in the 40% tax bracket. Based on the IRR method, should the expansion be undertaken?

Answer 1

Calculation of Kd
=	Interest(1-t)
=	0.09*(1-.4)
=	5.40%

Calculation of wacc
particulars	Amount of cap	weights	cost of cap	WACC
Debt	2000000	0.4	0.054	0.0216
Equity	3000000	0.6	0.14	0.084
	5000000	1		0.1056
	Ko = 10.56%

Yr	Cash flow	PVF @10.56%	PV @ 10.56%	PVF @35%	PV @ 35%
0	-2000000	1	-2000000	1	-2000000
1	1500000	0.9045	1356750	0.7407	1111050
2	1500000	0.8181	1227150	0.5487	823050
	Net present Value		583900		-65900

IRR=	0.1056+[583900*(35-10.56)]/(583900+65900)
	0.1056+[142705.16]/649800
	0.3252
IRR=	32.52%