A company is considering an investment in a project which would require an annua

Question

A company is considering an investment in a project which would require an annual initial outlay of $320,000 and produce expected cash flows in years 1-5 of $87,385 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 8%, Cost of Preferred stock 12%, Cost of common stock 16%
Long term debt currently makse up 20% of capital structure, preferred 10% and common stock 70%.

What is the net present value of this project: -(neg) $13,876, -(neg) $20,000, $0, $287,692 or $1568

Explanation / Answer

WACC = D *i *(1 - t) + P * r + E * r
where t is the tax rate.
where i is the interest rate,
r is the required return on equity,
D is the % of debt capital,
PE is the % of prefered capital
and E is the % of equity capital.

WACC = 0.20 * 0.08 + 0.10 * 0.12 + 0.70 *0.16 = 0.016 +0.012 + 0.112 = .14 Or 14%

Year Cash flow PVIF 14% PV cash flow 0 -$3,20,000 1 -$3,20,000 1 $87,385 0.877 $76,654 2 $87,385 0.769 $67,240 3 $87,385 0.675 $58,982 4 $87,385 0.592 $51,739 5 $87,385 0.519 $45,385 NPV -$20,000

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