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Alpha Industries is considering a project with an initial cost of $7.4 million. The project will produce cash inflows of $1.54 million a year for 7 years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is 1.5 percent. The firm has a pre-tax cost of debt of 8.6 percent and a cost of equity of 13.7 percent. The debt-equity ratio is .0.65 and the tax rate is 35 percent. What is the net present value of the project

Answer :

TomShelby

Answer:

NPV 115,000

Explanation:

The first step will be to calcualte the WACC

[tex]WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})[/tex]

Ke= cost of equity = 0.137

Equity weight 0.35

Kd= cost of debt = 0.086

Debt Weight 0.65

tax rate =  0.35

[tex]WACC = 0.137(0.35) + 0.086(1-0.35)(0.65)[/tex]

WACC 8.42850%

Then we adjust by the factor:

8.42850% + 1.5% = 9.9285%

Then we calcualte the present value of the cash flow from the project

[tex]C \times \frac{1-(1+r)^{-time} }{rate} = PV\\[/tex]

C 1.54

time 7

rate 0.099285

[tex]1.54 \times \frac{1-(1+0.099285)^{-7} }{0.099285} = PV\\[/tex]

PV $7.5150

And last, the NPV which isthe present value of the cashflow less the initial investment

7.515 - 7.4 = 0.115 = 115,000

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