Now assume that Plastico is considering a project that requires an initial inves
ID: 2756596 • Letter: N
Question
Now assume that Plastico is considering a project that requires an initial investment of $100 million and has the following projected income statement: This project is going to be financed at the same debt/equity ratio as the overall firm and is expected to last forever. Assume that there are no principal repayments on the debt (it too is perpetual) Evaluate this project from the equity investors' standpoint. Does it make sense? Evaluate this project from the firm's standpoint. Does it make sense?Explanation / Answer
Answer to part a:
Evaluation of project from the equity investors' standpoint:
EBIT $20 million
less: Interest ($4 million)
EBT $16 million
less: Taxes ($6.4 million)
EAT $9.6 million
Add: Depreciation $5 million
CFAT $14.6 million
Let Discount rate be 10%
NPV of project = PV of Cash Inflows - PV of Cash Outflows
= ($14.6 / 10%) - $100 million
= $146 - $100
= $46 million
Since NPV is positive, it is better to accept the project
It makes sense because interest payment is also considered here. It is appropriate to consider interest payment and take decision sine interest payment is a fixed payment and is a charge against profit
Answer to part b:
Evaluation of project from the equity firm's standpoint:
EBIT $20 million
less: Taxes ($6.4 million)
EAT $13.6 million
Add: Depreciation $5 million
CFAT $18.6 million
Let Discount rate be 10%
NPV of project = PV of Cash Inflows - PV of Cash Outflows
= ($18.6 / 10%) - $100 million
= $186 - $100
= $86 million
Since NPV is positive, it is better to accept the project
It doesnt make sense since interest payment is not considered,.
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