Antonio\'s is analyzing a project with an initial cost of $32,000 and cash inflo

ID: 2634457 • Letter: A

Question

Antonio's is analyzing a project with an initial cost of $32,000 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 0.6. The pre-tax cost of debt is 9.8 percent and the cost of equity is 12.4 percent. The tax rate is 34 percent. What is the projected net present value of this project?

Explanation / Answer

We first need to calculate the WACC of the company. WACC is the weighted average cost of cpital and would be used to calculate the NPV of the projetct

Debt/Equity ratio = 0.6

Debt = 0.6Equity

Weight of debt = Debt/(Debt+Equity)

=0.6Equity/(0.6Equity+Equity)

=0.6/1.6

=0.375

Weight of Equity = 1-0.375

=0.625

WACC = weight of equity*cost of equity+weight of debt*pretax cost of debt*(1-tax rate)

WACC = 0.625*12.4%+0.375*9.8%*(1-34%)

=10.18%

Now we need to calculate the NPV using 10.18% as the required rate of return

Hence, the NPV of the project is $14749.37

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Note: The formula for calculation of pesent value is cash flow/(1+rate of return)^(no. of years). For instance, the present value for year 1 = 27000/(1+10.18%)^1. NPV is the sum of present value of cash flows

Year Cash flow Present Value 0 -32000 -32000.00 1 27000 24506.36 2 27000 22243.02 NPV 14749.37

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Antonio\'s is analyzing a project with an initial cost of $32,000 and cash inflo

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