A company is considering a $10,000 project that will last 5 years. Annual after tax cash flows are expected to be $3,000 Target debt/equity ratio is 0.4 Cost of equity is 12% Cost of debt is 6% Tax rate 34% What is the project’s net present value (NPV)? A) -$1,460. B) +$1,460. C) 0. D) +1,245

B

Key here is figuring out the debt/equity is not the debt/cap ratio.

B?

does that make 40% debt 60% equity? how do you calculate the breakdown?

% of debt = (d/e)/(1+d/e) Edit: Sorry Skip…totally lazy of me… guess time to go and get some coffee!

Here’s a little algebra to help you solve this: Debt to Capital (weight of debt) is: D / (D + E) If we multiply the top and bottom of that fraction by 1/E, we get the following: (D/E) / (1 + D/E) So therefore, you can solve for the weight of debt by taking the debt-to-equity divided by the debt-to-equity plus 1. With that, the weight of equity is W(E) = 1 - W(D)

thanks!

wd + we = 1 wd = .4we .4we + we = 1 1.4we = 1 we = 0.714 wd = 0.286 then you can use WACC to find the cost of capital.

B, over here, as well.

.4we + we = 1 1.4we = 1 ? how do you get from here to there?

SkipE99 Wrote: ------------------------------------------------------- > .4we + we = 1 > > 1.4we = 1 ? > > > how do you get from here to there? weigfht of debt = D/E divided by 1 + D/E wgt of E = 1 - Wd boom

Ofcourse, B! Thanks everyone for explaining so well