KMART uses 70% common stock and 30% debt to finance operations. The after-tax co

Question

KMART uses 70% common stock and 30% debt to finance operations. The after-tax cost of debt is 5.4%, cost of equity is 15.4%. They are thinking about making a project that will produce cash inflow of $36,000 in first year alone. Cash inflow then grows 3% per year forever. What's the max amount KMART can initially invest in the project to avoid a negative net present value for project?

Explanation / Answer

=> WACC = 0.3*5.4%+0.7*15.4% =12.36% => r for this project =12.36% PV of future CF = 36000/(1.1236) + 36000*(1.03)/1.1236+36000*(1.03)^2/(1.1236)^2----- =32039.87 +36000/(12.36%-3%) =32039.87 +384615.38 =$416655.25 soto make NPV positive they should invest less than $416655.25

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