Question

Please include all equations!

Kottinger's Kamp Supplies is considering an investment in new manufacturing equipment. The equipment costs $220,000 and will provide annual aftertax inflows of $50,000 at the end of each of the next 7 years. The firm's market value debt/equity ratio is 25%, its cost of equity is 14%, and its pretax cost of debt is 7%. The firm's combined marginal federal and state tax rate is 40%. Assume the project is of approximately the same risk as the firm's existing operations.

What is Kottinger's weighted average cost of capital?

A) 8.91%

B) 9.99%

C) 10.86%

D) 11.14%

E) 12.04%

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

WACC = weight of debt * after tax cost of debt + weight of equity * cost of equity

debt/equity = 0.25

debt + equity = 1

=>

equity = 0.8

debt = 0.2

hence

WACC = 0.2 * 7% * (1-0.4) + 0.8 * 14%

= 12.04%

hence choose E)

NPV = -initial investment + PV of future cash flows

Present value = Future value/(1+i)^n

i = interest rate per period

n= number of periods

NPV = -220000 + 50000/1.1204 + 50000/1.1204^2 + 50000/1.1204^3 + 50000/1.1204^4 + 50000/1.1204^5 + 50000/1.1204^6 + 50000/1.1204^7

= 7899

hence choose B)