E 6./% 7Panelli\'s is analyzing a project with an initial cost of $102,000 and c

Question

E 6./% 7Panelli's is analyzing a project with an initial cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year two. 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 its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35- pereent What is the projected net present value of this project?

Explanation / Answer

Initial Cost = 102000

Cash Inflow for year 1 = 65000

Cash Inflow for year 2 = 74000

Debt-equity ratio = debt/equity = 0.45

So, Total Capital = Debt + Equity = 0.45 + 1 =1.45

Weighted Average Cost of Capital = After-tax cost of debt * percentage of debt + cost ofequity * percentage of equity = (4.8% * (0.45/1.45)) + (12.7% * (1/1.45)) = 1.49% + 8.76% = 10.25%

So, PV of Cash Inflow for year 1 = 65000/(1+10.25%) = 58956.92

PV of Cash Inflow for year 2 = 74000/(1+10.25%)2 = 60879.98

So, NPV of the project = -102000 + 58956.92 + 60879.98 = 17836.90

Please note that all calculations are rounded off to 2 decimals

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