The 5-year project requires equipment that costs $100,000. If undertaken, the sh
ID: 2806151 • Letter: T
Question
The 5-year project requires equipment that costs $100,000. If undertaken, the shareholders will contribute $20,000 cash and borrow $80,000 at 6% with an interest-only loan with a maturity of 5 years and annual interest payments. The equipment will be depreciated straight-line to zero over the 5-year life of the project. There will be a pre-tax salvage value of $5,000. There are no other start-up costs at year 0. During years 1 through 5, the firm will sell 25,000 units of product at $5; variable costs are $3; there are no fixed costs.
Given Information
r (debt) = 6%, r(asset)= 12%, r(equity)= 27.84%, Tax rate = 34%, Risk free rate = 2%, Debt to equity=4
What is the NPV of the project using the WACC methodology? Please give me the detailed answer
Explanation / Answer
WACC= we × kd+ we× ke
Kd= 0.06×(1-0.34)= 0.0396 or 3.96%
WACC= 0.8× 3.96+ 0.2×27.84
= 8.736%
Initial cost= 100000
Ocf:
Contribution pu= 5-3= 2 pu
Contribution or EBDIT=100000×2= 200000
Depreciation= 100000/5= 20000
EBIT= 180000
OCF= 180000(1-0.34)+20000=138800
Terminal cash flows=5000×(1-0.34)= 3300
NPV
CF0= 100000
CF1= 138800, F= 4
CF3= 138800+ 3300=142100
I= 8.736
CPT NPV
Npv=$ 645773.08
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