Panelli's is analyzing a project with an initial cost of $110,000 and cash inflows of $65,000 in year 1 and $74,000 in year 2. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of .45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project

Respuesta :

Answer:

$9,837

Explanation:

For computing the net present value first we have to determine the weighted cost of capital which is shown below:

WACC = [(Weight of common stock ×  cost of common stock) + (Weight of debt  × cost of debt) ×  [after tax cost of debt)] ÷ Total weight

= [(1.0 × 0.127) + (0.45 × 0.048)] ÷ 1.45

= 10.25%

=10.25%(approx)

Now the net present value is

= Present value of all year cash inflows - Initial Investment

= {[$65,000 ÷ (1.1025)] + [$74,000 ÷ (1.1025)^2]} - $110,000

= $58,957 + $60,880 - $110,000

= $9,837

We simply applied the above formula for computing the net present value.

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