Corporate Finance
WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)]
where E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate
In this case, we have the following values for these parameters:
E/V = percentage of equity to finance the project = 60%
D/V = percentage of debt to finance the project = 40%
Re = Cost of Equity = required return by stockholders = 18.36%
Rd = Cost of Debt = required return by debt holders = 10.68%
T= Tax Rate = 36% = 0.36
As such,
WACC = ((0.6) * 0.1836) + [((0.4) * 0.1068)*(1-0.36)] = 0.027 = 2.7%
The firm's weighted average cost of capital is 2.7%.
b. The Net Present Value is calculate according to the formula below.
So, r = 2.7% = 0.027
The initial investment (C0) is equal to the cost of the project, which is $45,000.
The cash flows C. are each equal to $13,000 for the next 20 years. So, T = 20. The formula now becomes
NPV = C x
(1 ? (1 + r)-T)
Initial Investment
NPV = $13,000 X (1-1.027-20) - $45,000 = -$35,851
The project should not be undertaken.
c.
, with the following explanations:
is the required rate of return on equity, or cost of levered equity is the company cost of equity capital with no leverage is the required rate of return on borrowings, or cost of debt.
is the debt-to-equity ratio.
is the tax rate
In this case, we have the following values:
D/E = 40/60=2/3
Rd = 10.68% = 0.1068
Re =…
