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Acme Co. wants to build a new facility that requires an initial investment of $1 million and will reduce costs by $100,000 forever. The company has a total value of $600,000 and outstanding debt of $400,000. What is the NPV of this project if the company has an after tax cost of debt of 6% and a cost of equity of 9%?
I hardly can wait to see your first attempt.
Behold my first attempt:
Cash Inflow = 100,000
Present value (PV) = 100,000 / 0.09 = 1,111,111
NPV = PV - 1,000,000 = 111,111
Does anyone know the correct answer?
Good, but that's only the first sentence. What about the other two?
I think you are referring to its Debt-Equity ratio of 0.67, but I have no idea what to do with it.
Too bad. You used the magic words. If you truly have "no idea", you should not have been given this problem unless it is a placement exam. If you truly have "no idea" you have not read your book or attended class and need to have a nice chat with your academic advisor and remember to discuss whether or not you should be in this class.
Sorry. When you have an idea, we can talk.
I would probably say the same thing in your position...
600,000*9% = 54,000
400,000*6% = 24,000
Therefore NPV = PV -78,000 = 1,033,111
?
One more prod: That's one year. Does it change over time? Read your definitions very carefully.
Okay, so if I calculate the WACC as 7%, then this gives me:
PV = 100,000 / 7% = 1,428,571
NPV = 428,571
Now its starting to make sense.
There's a name for that. "a clue". (Happy)