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Find the present value of the net cash flows

You are given the following net cash flows:

Year Net Cash Flow
______ ______________

0 $ 0
1 $ 1
2 $ 2,000
3 $ 2,000
4 $ 2,000
5 $ 0
6 ($ 2,000) Negative number

The firm's debt to equity ratio is 60% and the firm has $600,000 in debt. The cost of debt is 10% on the first $450,000 of debt and 18% on the remaining debt. Cost of equity is 14.88% and the tax rate is 40%.

Given the information present above, please find the present value of the net cash flows.

W-A-C-C = WdKd(1-t) + WpsKps + WcsKcs (see below for calculations)
.6(.12)(1-.4) + 0 + .4(.1488)
4.32 + 0 + 5.95
10.27 Required rate of return

Debt = 40%
Equity = 60%

Debt = $600,000 -> $450,000 * 10% = $45,000
$150,000 * 18% = $27,000
Total = $72,000

Cost of Debt $72,000 / $600,000 = 12%

Cost of Equity = 14.88%

NPV = NCF0 + NCF1 + NCF2 .... NCF6
_____ _____ _____
(1+r)^1 (1+r)^2 (1+r)6

= $0 + $1 + $2,000 + $2,000 + $2,000 + $0 + ($2,000)
______ ________ ________ ________ ______ _________
(1.1027) (1.1027)^2 (1.1027)^3 (1.1027)^4 (1.1027)^5(1.1027)^6

= $0 + $.90 + $1,644.80 + $1,491.61 + $1,352.70 + $0 + ($1,112.46)

NPV = $3,377.55 Answer?

Solution Preview

Hello!
You made a small mistake in the WACC calculation. Notice that you're given the debt/equity ratio (D/E), while the WACC calculation uses the D/(D+E) and E/(D+E) weights. So the appropriate weights to use in the WACC formula are not 0.6 ...

Solution Summary

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$2.19