Results 1 to 7 of 7

Thread: WACC and NPV question

  1. #1
    New Member
    Join Date
    Feb 2011
    Posts
    8

    WACC and NPV question

    Hi guys i have this question here and i have solved it to my best ability if anyone can confirm whether this is correct i'd really appreciate it.

    Bertelli's is analyzing a project with an initial cost of $55,000 and cash inflows of $33,000 a year for two years. 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 their operations and maintains a debt-equity ratio of .35. The after-tax cost of debt is 6 percent and the cost of equity is 11 percent. The tax rate is 34 percent. What is the projected net present value of this project?

    D/E ratio: 0.35
    Weight of Debt = Debt-Equity Ratio / (1 + Debt-Equity Ratio) = .35/ (1+.35) = .259 or 26%
    Weight of Equity = 1 / (1 + Debt-Equity Ratio) = 1 / (1 + .35) = .740 or 74%
    Cost of debt = 6%
    Cost of equity = 11%
    Tax rate = 34%

    WACC = (E/V) x Re + (Dm/V) x (Rd x (1-t))
    = .26 x .06 + .74 x (.11x.66)
    = 0.0693 or 6.93%

    NPV = -$55000 + $33000/(1+WACC)^1 + $33000/(1+WACC)^2
    = -$55000 + $33000/(1.0693) + 33000/(1.0693)^2
    = $4722.539

  2. #2
    New Member
    Join Date
    Feb 2011
    Posts
    8

    Re: WACC and NPV question

    its funny how i actually have a solved question here and still no replies? guys? i really need some clarification/confirmation.

  3. #3
    Elite Member
    Join Date
    Apr 2005
    Location
    PA, USA
    Posts
    8,222

    Re: WACC and NPV question

    In an effort to help as many students as possible, we sometimes feel that a very long problem may be a burden to other students. We ahve only volunteers, here. When you type that much, it assaults the eyes and one must overcome the initial shock of how long it will take just to read it. Have a little patience. We will try to get to it.

  4. #4
    Elite Member
    Join Date
    Apr 2005
    Location
    PA, USA
    Posts
    8,222

    Re: WACC and NPV question

    Quote Originally Posted by dawg87
    WACC = (E/V) x Re + (Dm/V) x (Rd x (1-t))
    = .26 x .06 + .74 x (.11x.66)
    = 0.0693 or 6.93%
    As long as your post is, you have not defined ANY of the terms in this formula. I suppose the catalogue is just above, but there is no listed relationship.

    Explain this formula to me. What does each piece mean. In this way, everyone will know if you made any deliberate errors.

  5. #5
    New Member
    Join Date
    Feb 2011
    Posts
    8

    Re: WACC and NPV question

    Weighted Average Cost of Capital = (E/V) x Re + (Dm/V) x (Rd x (1-t))

    Where:
    Re = cost of equity
    Rd = cost of debt
    E = market value of the firm's equity
    D = market value of the firm's debt
    V = E + D
    E/V = percentage of financing that is equity
    D/V = percentage of financing that is debt
    Tc = corporate tax rate

    does this help?

  6. #6
    Elite Member
    Join Date
    Apr 2005
    Location
    PA, USA
    Posts
    8,222

    Re: WACC and NPV question

    I'm not the one asking for help. I'm suggesting that you provide and understand definitions and that this will cause you to gain confidence in your implementaion of the provided solution.

    Having said that, did you translate all the information correctly? Did you substitute correctly? Was your arithmetic good?

    If you can answer those three questions, where does that leave us?

  7. #7

    Re: WACC and NPV question

    I have two solutions to this question and would like some help on each one is correct..


    Bertelli's is analyzing a project with an initial cost of $55,000 and cash inflows of $33,000 a year for two years. 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 their operations and maintains a debt-equity ratio of .35. The after-tax cost of debt is 6 percent and the cost of equity is 11 percent. The tax rate is 34 percent. What is the projected net present value of this project?

    Given:
    Initial cost = $55,000
    Cash Inflow = $33,000 (a year for 2 years)
    Risk = equal as current firm
    Debt-equity ratio = .35, Therefore Equity is 0.65
    After tax cost of debt = 6%
    Cost of equity = 11%
    Tax Rate = 34%
    Weighted Avg Cost of Capital (WACC)= After Tax cost of debt X Debt + Cost of Equity X Equity X (1- Tax Rate)

    WACC= (0.65) * (11%) + (0.35) * (6%) * (1-0.34)
    WACC = 8.536%
    Prevent Value of an Annuity
    Year 1 Discount factor = 1/1.08536 = 0.9214,
    Year 2 Discount factor = 0.9214/1.0925 = 0.8434
    Present Value of inflows for 2 years = 33,000*0.9214 + 33,000*0.8434 = $58,238.40
    Therefore, PV of Cash flows is $58,238.40

    Net Present Value = Present Value of All Inflows - Present Value of All Outflows
    Therefore, NPV = $58,238.40 - 55,000 = $3,238.40
    The projected net present value of this project is $3,238.40

    OR DO I USE THIS FORMULA FOR NPV ???

    NPV = -$55000 + $33000 X (1- (1 + WACC)^2)/WACC
    = -55,000 + 33,000 * (1-(1+0.0854)^2)/0.0854
    = -22,000 * (-2.0854)
    NPV = 45,878.8

Bookmarks

Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •