Travis & Sons has a capital structure that is based on 45 percent debt, 5 percent preferred stock, and 50 percent common stock. The pretax cost of debt is 8.3 percent, the cost of preferred is 9.2 percent, and the cost of common stock is 15.4 percent. The tax rate is 21 percent. A project is being considered that is equally as risky as the overall company. This project has initial costs of $287,000 and annual cash inflows of $91,000, $248,000, and $145,000 over the next three years, respectively. What is the projected net present value of this project?

The projected net present value of this project is $101,488

Explanation:

In order to calculate the projected net present value of this project, first we would need to calculate the WACC as follows:

WACC=Respective cost*Respective weight

Aftertax cost of debt=8.3(1-tax rate)

=8.3(1-0.21)=6.557%

Hence, WACC=(6.557*0.45)+(0.05*9.2)+(0.5*15.4)

=11.11065%

Therefore, to calculate the projected net present value of this project we would have to use the following formula:

NPV=Present value of inflows-Present value of outflows

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=91000/1.1111065+248000/1.1111065^2+145000/1.1111065^3

=$388,488.32

Therefore, NPV= $388,488.32-$287000

=$101,488

The projected net present value of this project is $101,488

$101,493

Explanation:

Net present value is the Net value all cash inflows and outflows in present value term. All the cash flows are discounted using a required rate of return.

First we have to calculate the WACC to determine the cost of capital for Net present value calculation.

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

Formula for WACC

Weighted Average Cost of Capital = (Cost of common stock x Weightage of common stock ) + (Cost of preferred Stock x Weightage of preferred Stock ) + (Cost of Debt (1 -t) x Weightage of Debt)

Placing Values in the formula

Weighted Average Cost of Capital = ( 15.4% x 50% ) + ( 9.2% x 5% ) + ( 8.3% x ( 1 - 0.21 ) x 45% ) = 7.7% + 0.46% + 2.95% = 11.11%

Now we will calculate the NPV

Net Present Value = Initial Investment + PV of all future cash flows

NPV = ($287,000) + [ $91,000 x ( 1 + 11.11% )^-1 ] + [ $248,000 x ( 1 + 11.11% )^-2 ] + [ $145,000 x ( 1 + 11.11% )^-3 ]

NPV = ($287,000) + $81,901 + $200,884 + 105,708 = $101,493

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