1. The NPV for a project with estimated cash flows of $45,000 per year for 5 yea

Question

1. The NPV for a project with estimated cash flows of $45,000 per year for 5 years, initial investment $150,000, cost of capital 9.5% is $75,000. True or false.

2. The IRR for this same project is ?

3. If my capital structure is 30% debt and 70% equity and my cost of debt is 5% (after tax) and cost of equity is 8%, my WACC is 7.1%. True or false.

4. The biggest differences in calculating the cost of equity for common stock and new issue common stock are flotation costs and undervaluation. True or false.

Explanation / Answer

1. The NPV of the Project is 22,787 as shown below:

Hence the statement 1 is FALSE

2. IRR of the project

To get the IRR we need to equate the cash flows for 5 year with the inital outflow and evaluate R.

Therefore, 45000/1+r + 45000/(1+r)^2 + 45000/(1+r)^3 + 45000/(1+r)^4 + 45000/(1+r)^5 =150,000.

Evaluating for r by trial and error method, we get as equal to 15.24%.Hence IRR of this project is 15.24%

3. WACC is 0.3*5 + 0.7*8 =7.1%. Therfore it is TRUE

4. This stamenent is true as often new stock issue is generally undervalued and is having issue costs or floation coasts assocoated with it

Year 0 1 2 3 4 5 Initial inv -150000 Cash Flows 45000 45000 45000 45000 45000 Discounted Cash flows at 9.5% -150000 41095.89 37530.49 34274.42 31300.84 28585.24 NPV $ 22,786.90

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