SFE Inc. has 1 million shares of common stock outstanding at a book value of $40

Question

SFE Inc. has 1 million shares of common stock outstanding at a book value of $40 per share. The stock trades for $50 per share. It also has $10 million in face value of debt (corporate bonds of 5 years with coupon rate 10.5%) that trades at 110% of face value. The company’s equity beta is 1.2. The risk-free rate is 4% and the market return is 10%. The tax rate is 35%.

The company is considering a project which requires purchasing a machine for $200,000 today (year 0). The machine will be depreciated straight-line over the next 5 years to a salvage value of zero. The revenue from this project is $350,000 each year, for years 1 to 5. The cost of good sold is $250,000 every year. Fixed operating cost is $30,000 each year, for the next five years. What is the NPV of the project? Please explain and show your answer.

Explanation / Answer

year0 year1 year2 year3 year4 year5 NPV revenue from the project 0 350000 350000 350000 350000 350000 Depreciation 0 40000 40000 40000 40000 40000 cost of goods sold 0 250000 250000 250000 250000 250000 Operating expenes 0 30000 30000 30000 30000 30000 Earnings before interest and tax 30000 30000 30000 30000 30000 tax@35% 10500 10500 10500 10500 10500 Earnings after tax 19500 19500 19500 19500 19500 Add ; depreciation 40000 40000 40000 40000 40000 Cash flows -200000 59500 59500 59500 59500 59500 discount factor@ 10% 1 0.909090909 0.826446281 0.751315 0.683013 0.620921 Present value @ 10% -200000 54090.90909 49173.55372 44703.23 40639.3 36944.82 25551.81

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