Question

4 Consider a project of the Pearson Company. The timing and size of the incremental after-tax cash flows for an all-equity firm are $-1000, $295, $590. $545. $500 from year 0 to 4 respectively. The unlevered cost of equity is 36%. a. Calculate the NPV? Should this project be accepted? b. The firm finances the project with $23000 debt at 9% with $100 after-tax flotation costs. Principal is repaid at $2000 per year with added interest. Pearson's tax rate is 50%. The net present value of the project under leverage? Now, Should this project be accepted?

please solve questions A and B and show your work.

Answer 1

a. Calculation of NPV of Project

Years	Cash Flow	PV Factor @ 36%	Amount in $
0	-1000	1.0000	-1000.00
1	295	0.7353	216.91
2	590	0.5407	318.99
3	545	0.3975	216.66
4	500	0.2923	146.16
		NPV	-101.28

Since, NPV is negative - Project should not be accepted.

b. Calculation of NPV of Project

Years	Cash Flow	PV Factor @ 4.5%*	Amount in $
0	-1100**	1.0000	-1100.00
1	295	0.9569	282.30
2	590	0.9157	540.28
3	545	0.8763	477.58
4	500	0.8386	419.28
		NPV	619.44

* Discount Rate = Cost of debt x (1 - Tax Rate) = 9 x 0.50 = 4.5%

** Floatation Cost is to be added as extra outflow at the beginning.

Since, NPV is positive - we should accept the project.