Antonio\'s is analyzing a project with an initial cost of $46,000 and cash inflo

ID: 2767265 • Letter: A

Question

Antonio's is analyzing a project with an initial cost of $46,000 and cash inflows of $27,000 a year for 2 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 0.9. The pre-tax cost of debt is 9.2 percent and the cost of equity is 12.1 percent. The tax rate is 34 percent. What is the projected net present value of this project?

$43,503.95

$4,021.78

$883.65

$1,338.87

$14,791.34

Explanation / Answer

Calculation of Discount Rate (Weighted Average cost of Capital):

Formula :

Weighted Average cost of Capital = (Cost of Equity * weight of equity) + (cost of debt * weight of debt)

Cost of Equity =

12.100%

Weight of equity = 1- weight of debt = 1-0.4737

0.5263

Cost of debt (after tax) = pre-tax cost of debt * (1- tax) = 9.2% * (1-34%) =

6.072%

Weight of Debt = 0.9 / (1+0.9)

0.4737

Weighted Average cost of Capital = (12.1% *0.5263) + (6.072%*0.4737) =

9.2446%

Calculation of projected net present value of this project:

Annual Cash inflows for next 2 years

$ 27,000.00

Present value of $1 Annuity (9.2446%, 2 years )

1.75329

Present value of cash inflows = 27000*1.75329 =

$ 47,338.87

Less: Initial Investment

$ (46,000.00)

Net Present value =

$ 1,338.87