Your company is considering an investment in a project which would require an in

Question

Your company is considering an investment in a project which would require an initial outlay of $300,000 and produce expected cash flows in Year 1 through 5 of $87,385 per year. You have determined that the current after tax cost of the firm’s capital (e.g the required rate of return) for each source of financing is as follows:

Cost of Debt………………………………….8 Percent

Cost of Preferred Stock………………….12 Percent

Cost of Common Stock……………………16 Percent

Long term debt currently makes up 20 percent of the capital structure, preferred stock 10 percent of this structure, and common stock the remaining 70 percent. What is the net present value of this project?

Explanation / Answer

All Amounts in $ For working out the Net Present Value, we first need to determine the Weighted Average Cost of Capital for the Company Particulars of Capital % in Amount Cost Weighted Capital Base in $ in % Amount Debt 20% 60000 8% 4800 Preferred Stock 10% 30000 12% 3600 Common Stock 70% 210000 16% 33600 Total Outlay 300000 42000 Thus, the Weighted Average Cost of Capital which is to be considered for calculating the Net Present Value is 14% From the amounts and the WACC (Weighted Average Cost of Capital) thus calculated, the Net Present Value works out to -$ 0.19 or NIL

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