Question

Antonio's is analyzing a project with an initial cost of $45,000 and cash inflows of 30,000 a year for two years. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance their operations and maintains a debt-equity ratio of 40. The pre-tax cost of debt is 8 percent and the cost of equity is 12 percent. The tax rate is 34 percent. What is the projected net present value of this project? O A $6,471.37 OB $6,700.39 OC $7.010.27 OD $7.056.67 OE $7,066.12

Answer 1

Weight of equity = 1 / (1 +d/e ratio)

Weight of equity = 1 / (1 + 0.4)

Weight of equity = 0.7143

Weight of debt = 1 - 0.7143 = 0.2857

WACC = Weights * costs

WACC = 0.7143*0.12 + 0.2857*0.08*(1 - 0.34)

WACC = 0.085716 + 0.015085

WACC = 0.1008 or 10.08%

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

Net present value = -45,000 + 30,000 / (1 + 0.1008)^1 + 30,000 / (1 + 0.08)^2

Net present value = $7,010.27