# Calculating WACC and then NPV of Projects

Question 1

A company has a capital structure composed by 20% Debt and 80% Equity. The cost of the debt is 5% per year while the cost of equity is 15% per year.

The company is considering two different projects. The cash flows of the two projects are reported in the table below.

Please see attached.

A company has a capital structure composed by 20% Debt and 80% Equity. The cost of the debt is 5% per year while the cost of equity is 15% per year.

The company is considering two different projects. The cash flows of the two projects are reported in the table below.

Time Project A Project B

0 ($120,000) ($150,000)

1 $25,000 $38,000

2 $35,000 $38,000

3 $50,000 $50,000

4 $50,000 $50,000

5 $35,000 $50,000

a) Compute the NPV of each project.

b) Which project the company should accept? Explain.

Question 2

The company LL has a capital structure composed by 30% of debt and 70% of equity and is planning to invest in a new industry.

Following the standard technique in Corporate Finance, the financial manager of the company finds that the two main pure plays of the new industry have the following characteristics.

Company PP Company CC

Stock Beta 0.80 1.00

Fraction of Debt 0.25 0.40

Fraction of Equity 0.75 0.60

Assume the expected return on the market is 8% while the risk free rate of interest is 3% per annum. The company pays a 4.5% rate for the debt.

Compute the WACC of this project. [Hint: Carefully explain each step you need to compute the WACC.]

Question 3

Assume you are considering and investment in a project that requires an initial outlay of $225,000 and will produce after-tax cash flows of $35,000 per year for the next 15 yrs. Your firm uses 50% debt and 50% equity in its financing. The after-tax cost of the debt and equity are 9% and 15% respectively.

a) What is the project WACC?

b) What is the project NPV? Should the project be accepted?

#### Solution Preview

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A company has a capital structure composed by 20% Debt and 80% Equity. The cost of the debt is 5% per year while the cost of equity is 15% per year.

The company is considering two different projects. The cash flows of the two projects are reported in the table below.

Time Project A Project B

0 ($120,000) ($150,000)

1 $25,000 $38,000

2 $35,000 $38,000

3 $50,000 $50,000

4 $50,000 $50,000

5 $35,000 $50,000

a) Compute the NPV of each project.

The NPV is calculated in the excel sheet. The discounting rate is the WACC and is calculated from the given proportion of debt and equity and the cost given. The NPV of Project A is $13,849 and of Project B is $5,844

b) Which project the company should accept? Explain.

Both ...

#### Solution Summary

The solution explains how to calculate the WACC and then use it to calculate the NPV of projects