Antonio\'s is analyzing a project with an initial cost of $44,000 and cash inflo

Question

Antonio's is analyzing a project with an initial cost of $44,000 and cash inflows of $26,000 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 0.7. The pre-tax cost of debt is 8.8 percent and the cost of equity is 11.9 percent. The tax rate is 34 percent. What is the projected net present value of this project?

$3,902.95

$1,495.15

$14,129.79

$41,558.20

$986.80

Antonio's is analyzing a project with an initial cost of $44,000 and cash inflows of $26,000 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 0.7. The pre-tax cost of debt is 8.8 percent and the cost of equity is 11.9 percent. The tax rate is 34 percent. What is the projected net present value of this project?

$3,902.95

$1,495.15

$14,129.79

$41,558.20

$986.80

Explanation / Answer

Answer;

Calculation of Discount rate / WACC:

WACC = Cost of debt * weight of debt + Cost of Equity * weight of equity

Cost of Debt = Pretax Cost * (1- Tax) = 8.8% * (1-0.34) = 5.808%

WACC = (5.808 * 0.7/ 1.7) + (11.9 * 1/ 1.7) =

9.39%

Calculation of NPV of the Project :

Year

Cash Flows (CF)

PVF (9.39%)

PV = CF *PVF

Initial Costs

0

-44000

1

$ (44,000.00)

Cash inflows

1 to 2

26000

        1.74981

$    45,495.15

Net Present value = Sum of PVs

$       1,495.15

Calculation of Discount rate / WACC:

WACC = Cost of debt * weight of debt + Cost of Equity * weight of equity

Cost of Debt = Pretax Cost * (1- Tax) = 8.8% * (1-0.34) = 5.808%

WACC = (5.808 * 0.7/ 1.7) + (11.9 * 1/ 1.7) =

9.39%

Calculation of NPV of the Project :

Year

Cash Flows (CF)

PVF (9.39%)

PV = CF *PVF

Initial Costs

0

-44000

1

$ (44,000.00)

Cash inflows

1 to 2

26000

        1.74981

$    45,495.15

Net Present value = Sum of PVs

$       1,495.15

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