Huata Ltd has 500,000 ordinary shares outstanding with a beta of 1.4, and the cu

Question

Huata Ltd has 500,000 ordinary shares outstanding with a beta of 1.4, and the current share price is $1.6.  The dividend yield is 5.7 percent and dividends increase by 4.2 percent annually. The company has issued $450,000 of bonds that are selling at 2% above their nominal/face value offering a yield to maturity of 6.8 percent. The tax rate is 35 percent. The firm is considering a project that has the same risk level as the firm’s current operations, an initial cost of $328,000 and cash inflows of $52,500, $155,000, and $225,000 for Years 1 to 3, respectively.

a.       What is the NPV of the project?

b.       If tax rates decline explain the impact on the Projects NPV.

c.       If the market value of the bonds dropped 2%, then what would be the impact on the NPV?

Explanation / Answer

a) cost of equity = 5.7 + 4.2 = 9.9%

cost of debt = 6.8*0.65 = 4.42%

WACC = 7.90%

NPV = 32,899.43

b) If tax rates decline, the after cost of debt would increase thereby increasing WACC. So NPV would decrease

c) If the market value of bonds dropped, it would indicate an increase in yield. This woud increase WACC and lower NPV

Amount weight cost weight*cost equity         800,000.00 0.6354 9.90% 0.0629 debt         459,000.00 0.3646 4.42% 0.0161

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