Answer to Question #42114 in Finance for Weah

Question

A project generates net (after-tax) cash flows of $20 million every year for 4 years. The investment is $48 million. The tax rate is 40%. The firm has a target debt ratio (debt ratio = debt/value) of 45%.

The firm’s current bonds have 5 years left to maturity, a coupon rate of 7% with annual coupons, a face value of $1000 and currently trade for $960. The (before-tax) cost on any new debt will be the same as the yield to maturity on the current bonds.

For the equity, they will use $6,000,000 in preferred stock and the rest will be from retained earnings. The preferred stock has a dividend of $4 with a price of $42. Issue costs on preferred stock are $2.

To estimate the cost of retained earnings, the firm expects to pay a dividend of $2.5 per share next year. The retention rate is 40% and the return on equity is 25%. The current stock price is $50.

Use the weighted average cost of capital (WACC) to find the net present value (NPV) of the project.