White Mountain Consulting is evaluating a 1-year project that would involve an initial investment in equipment of 24,200 dollars and an expected cash flow of 26,300 dollars in 1 year. The project has a cost of capital of 7.65 percent and an internal rate of return of 8.68 percent. If White Mountain Consulting were to use 24,200 dollars in cash from its bank account to purchase the equipment, the net present value of the project would be 232 dollars. However, White Mountain Consulting has no cash in its bank account, so using money from its account is not possible. Therefore, the firm would need to borrow money to raise the 24,200 dollars. If White Mountain Consulting were to borrow money to raise the 24,200 dollars, the interest rate on the loan would be 5.25 percent. White Mountain Consulting would receive 24,200 dollars from the bank at the start of the project and would pay 25,471 dollars to the bank in 1 year. What is the NPV of the project if White Mountain Consulting borrows 24,200 to pay for the project?
Answer:
Given that:
White Mountain Consulting is evaluating a 1-year project that would involve an initial investment in equipment of 24,200 dollars and an expected cash flow of 26,300 dollars in 1 year.
If White Mountain Consulting were to borrow money to raise the 24,200 dollars, the interest rate on the loan would be 5.25 percent.
Hence, if we evaluate NPV of the project assuming that White Mountain Consulting borrows 24,200 to pay for the project, cost of capital = 5.25%
No information on tax is given.
NPV of the project if White Mountain Consulting borrows 24,200 to pay for the project = 26300 / (1 + 5.25%) - 24200 = $788.12
NPV of the project if White Mountain Consulting borrows 24,200 to pay for the project = $788.12
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