A proposed project lasts 3 years and has an initial investment of $500,000. The

Question

A proposed project lasts 3 years and has an initial investment of $500,000. The after tax cash flows are estimated at $120,000 for year 1, $240,000 for year 2, and $240,000 for year 3. The firm has a target debt/equity ratio of 0.6. The firm’s cost of equity is 15% and its cost of debt is 8%. The tax rate is 35%. What is the NPV of this project? (hint: remember that the D/E is saying that debt is 60% of equity. In other words, you need to find D/A and E/A for the appropriate weights using the formulas:

  D/E/(1+ D/E) =% or weight of debt and 1/(1+D/E) = % or weight of equity.)

Explanation / Answer

If equity Is "1" , Then Debt = .60 *1 = .60

So total = 1 +.6 = 1.60

weight of Debt = .60 /1.60 = .375

weight of equity = 1/1.60 = .625

calculation of WACC

Calculation of NPV

Weight (A) Cost (B) weighted cost (A*B) after tax cpst of debt .375 5.20   [8(1-.35)] 1.95 equity .625 15 9.375 WACC 11.325% (approx 11.34%)

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