Bertelli\'s is analyzing a project with an initial cost of $55,000 and cash infl

Question

Bertelli's is analyzing a project with an initial cost of $55,000 and cash inflows of $33,000 a year for two years. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance their operations and maintains a debt-equity ratio of .35. The aftertax cost of debt is 6 percent and the cost of equity is 11 percent. The tax rate is 34 percent. What is the projected net present value of this project?

Explanation / Answer

Net present value PV of inflows - PV of outflows

WACC = weight of debt * cost of debt+ weight of equity * cost of equity

= (0.35/1.35) * 6 + ( 1/1.35)*11= 9.7%

NPV = 33000 PVIFA ( 9.7%,2) - 55000 = 57504 - 55000 = 2504.14

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