Question

You work as the chief financial officer for large auto parts supply company located in the Midwest. You have an opportunity to expand your existing line of business that will cost your company $1 million up front (year 0). You forecast that the opportunity will generate net cash inflows of $80,000 in the first year, and then will grow at 2% per year indefinitely thereafter. Your company's capital structure is comprised of 20 percent debt and 80 percent common stock. The pre-tax cost of debt is 10% and the cost of common stock is 13.5%. If your company's tax rate is 40%, what is the projected net present value of this opportunity?

Answer 1

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3 Colemolation of W ale WACC - kost of Debt (t tax )XWp + Cost of Equity & We - 10% (1 -0.40) X0-20 + 13.5%. X 0.80 = 1.2%.+ 10.8 - 12% NPY - Present Value of Cash Enflow-Present Value of cash Arfler - CF |CF(1+g) 1 7 where g is growth sats [1+ WACC)" (INACG-9) I 4 WACC is weighted (1 + WACC) Aug cost of capital 80,000 + (80,000 (1 + 0.02)) (1.12)" 0.12 - 0.02 – 1000000 (1.12721 71,428.57 to 7 2 8577.43 -1000000 = = -200,000 The project has rejativo NOV