What is the net present value of the project?

Question

Alpha Industries is considering a project with an initial cost of $8.8 million. The project will produce cash inflows of $1.68 million per year for 8 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.85 percent and a cost of equity of 11.43 percent. The debt–equity ratio is .68 and the tax rate is 40 percent. What is the net present value of the project?

$772,720

$439,544

$695,448

$662,331

$803,629

Answer 1

$772,720.

First, identify the cost and the inflows for 8 years. The project costs $8.8M today, and will yield inflows of $1.68M for years 1-8 (but remember, a dollar today is worth more than a dollar tomorrow so we need to talk in present value terms).

Next, calculate the WACC, but be sure that you subtract the cost of taxes on debt and that 0.68 debt-equity means the total value is 1.68 and equity is 1. Your WACC, also your discount rate, should come out to be 8.22%.

Then, calculate the NPV using 8.22% as a discount rate and keeping in mind the initial cost of the project. Final NPV is $772,720, which means you would accept this project.