Burns and Nuble is considering an investment in a project which would require an

Question

Burns and Nuble is considering an investment in a project which would require an initial outlay of $350,000 and produce expected cash flows in years 1-5 of $95,450 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows:

Cost of Long-Term Debt: 7%

Cost of Preferred Stock: 11%

Cost of Common Stock: 15%

Long term debt currently makes up 25% of the capital structure, preferred stock 15%, and common stock 60%. What is the net present value of this project?

Explanation / Answer

WACC = Weight of Debt *Cost of Long-Term Debt: + Weight of preferred stock*Cost of Preferred Stock + Weight of common stock*Cost of Common Stock

WACC = 25%*7 + 15%*11 + 60%*15

WACC = 12.40%

Net present value of this project = Annual Cash flow*PVIFA(rate,nper) - Initial Investment

Net present value of this project = 95450*PVIFA(12.40%,5) - 350000

Net present value of this project = 95450*3.56933953 - 350000

Net present value of this project = - $ 9306.54

Note: Since NPV is negative the project is not viable

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