Burns and Nuble is considering an investment in a project which would require an

Question

Burns and Nuble is considering an investment in a project which would require an initial outlay of $320,000, and produce expected cash flows in years 1 through 5 of $87,385 per year. You have determined that the current after tax cost of the firms capital (Required Rate of Return) for each source of financing is as follows: Cost of Long Term Debt: 8%, Cost of Preferred Stock: 12%, Cost of Common Stock: 16%, Long Term Debt currently makes up 20% of the Capital Structure, preferred stock-10%, and Common Stock-70%. What is the Net Present Value of this project: A, $13,876, B, $20,000, C, $0, D, $287,692, E, $1,568. from marycamillam@gmail.com

Explanation / Answer

The NPV should be -20,000, the options provided has a possitive NPV of $20,000.

Weights assigned to debt = .20 20.00% Weights assigned to Preferred stock= .10 10.00% Weights assigned to Common stock= .70 70.00% Cost of debt 8.00% Cost of Preferred stock 12.00% Cost of Common stock 16.00% WACC = Wd x kd + Wp x Kp + We x ke WACC = (.20 x .08) + (.10 x .12) + (.70 x .16) 14.00% Initial Cash Outflow $320,000 Cash Flow for 5 years $ 87,385

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