WACC Comprehensive A company has a proposed 2-year project with the cash flows s
ID: 2769485 • Letter: W
Question
WACC Comprehensive
A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1, the risk-free rate is 4.9, and the expected market risk premium is 6%. The bonds for this company pay interest semiannually and have a coupon interest rate of 8%, 20 years to maturity, a face value of $1,000, and a current price of 1,148.43. If the corporate tax rate is 39%, what is the NPV of the proposed project for this firm?
The correct answer is -1,366. Show step by step how I arrive at this answer.
Years Cash Flows 0 -4,000 1 1,000 2 2,000Explanation / Answer
Ke=Rf+Beta(Rm-Rf)
= 4.9+(1*6)
= 10.90%
If a bond pays 8% on an annual basis and compounds semiannually, then an investor who invests $1,000 in this bond will receive $40 of interest after the first 6 months ($1,000 x .04), and $41.60 of interest after the next 6 months ($1,040 x .04). The investor received a total of $81.60 for the year, which means that while the nominal rate was 6%, the effective rate was 8.16%.
Kd = I(1-t)
= 8.16(1-0.39)
= 4.98
WACC = (We*Ke)+(Wd*Kd)
= (10.90*0.60)(4.98*0.40)
= 6.54+ 1.992
= 8.532
Years
Cash Flows
PVF@ 8.532
Present value
0
-4,000
1
-4000.00
1
1,000
0.921395391
921.40
2
2,000
0.848969466
1697.94
Total
-1380.67
Years
Cash Flows
PVF@ 8.532
Present value
0
-4,000
1
-4000.00
1
1,000
0.921395391
921.40
2
2,000
0.848969466
1697.94
Total
-1380.67
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