Stasis Inc. continually adjusts its capital structure to maintain a fixed debt t

Question

Stasis Inc. continually adjusts its capital structure to maintain a fixed debt to equity ratio. Stasis is considering an investment project that requires an initial outlay of $639,750, and is expected to yield an indefinite cash flow of $111,500 per annum before tax. Assume the investment does not result in any depreciation allowances. In accordance with its preferred capital structure, Stasis borrows $131,500 to help finance the project, covering the remaining cost by issuing new equity. Assume there are no flotation costs and no effects of the project on networking capital. Suppose the expected annual rate of return on the firm's debt is 6%, while the expected annual return on its equity is 13%. Assume that the corporate tax effects of debt approximate the overall effects, and that the corporate tax rate is 34%. Calculate the annual cash flow to levered equity from the project. Hence obtain the NPV of the project using the FTE approach.

Explanation / Answer

Stasis Inc. continually adjusts its capital structure to maintain a fixed debt t

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