Alpha Industries is considering a project with an initial cost of $8.6 million. The project will produce cash inflows of $2.04 million per year for 6 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.79 percent and a cost of equity of 11.39 percent. The debt–equity ratio is .66 and the tax rate is 35 percent. What is the net present value of the project? Multiple Choice $656,266 $625,015 $758,352 $506,837 $729,185

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andromache andromache · Answer 1 · 2020-07-03T04:22:41+02:00

Answer:

$729,185

Explanation:

The computation of the net present value of the project is shown below:-

After-tax cost of debt = Cost of debt × (1 - Tax rate)

= 5.79% × (1 - 0.35)

= 5.79% × 0.65

= 3.76%

Debt-equity ratio = Debt ÷ Equity

we assume Equity = x

Debt = 0.66 x

Total = 1.66 x

WACC = Respective costs × Respective weight

= (x ÷ 1.66 x × 11.39) + (0.66 ÷ 1.66x × 3.76%)

= 6.861445783 + 1.494939759

= 8.356385542 %

Net present value = Cash inflow × (Discount rate^time period - 1) ÷ (WACC × (1 + WACC)^Number of years - Initial cost

= $2,040,000 × (1.0836^6 - 1) ÷ (0.0836 × 1.0836^6) - $8,600,000

= $728,559

which is nearest to

= $729,185