Question

D/(D+E) D/E* (1/(1+D/E)) Question 2: Pixelworks is might take on a new project which would cost $10 million dollars and generate cash flows of $5 million over the next 3 years. The project's risk is similar to the risk of the company's current assets. The company's current equity beta is 2.25 and its debt-to-equity ratio is 1/2. The YTM on company debt is 9% and the company's marginal tax rate is 40%. The risk-free rate is 4% and the market risk premium is estimated at 5%. Should Pixelworks proceed with the project?

Answer 1

Cost of Equity using CAPM =Risk free Rate+Beta*Market Risk Premium =4%+2.25*5% =15.25%
Cost of Debt =9%
WACC =Weight of Equity*Cost of Equity +Weight of Debt*Cost of Debt*(1-Tax Rate) =2/3*15.25%+1/3*9%*(1-40%) =11.9667%

NPV of Project =PV of Cash flows -Initial Investment =5*((1-(1+11.9667%)^-3)/11.9667%)-10 =2.02 million

Since NPV is positive it should be accepted