Douglass Enterprises has a capital structure which is based on 40 % debt, 10 % preferred stock, and 50 % common stock. The after-tax cost of debt is 6 %, the cost of preferred is 7 %, and the cost of common stock is 9 %. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $125,000 and cash inflows of $76,000 a year for two years. What is the projected net present value of this project?

Question

Quizplus · Accepted Answer

The correct answer is A because the project's NPV is $11,275.07. This is calculated by taking the present value of the cash inflows minus the initial cost of the project. The present value of the cash inflows is calculated by multiplying the cash inflows by the discount factor, which is the present value of $1 received at the end of each year. The discount factor is calculated by dividing 1 by the sum of 1 plus the cost of capital raised to the power of the number of years. In this case, the cost of capital is 8%, and the number of years is 2. The discount factor is therefore 0.8573. The present value of the cash inflows is therefore $76,000 x 0.8573 = $65,298.88. The initial cost of the project is $125,000. Therefore, the NPV is $65,298.88 - $125,000 = $11,275.07.

Douglass Enterprises Has a Capital Structure Which Is Based on 40