A company has a project with an initial after-tax cash savings of $40,000 at the end of the first year. These savings will increase by 2% annually. The firm has a debt-equity ratio of 1/3, a cost of equity of 16%, a cost of debt of 10%, and a 35% tax rate. The project is equal in risk to the current overall risk of the company. What is the present value of the project?

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Quizplus · Accepted Answer

The present value of the project can be calculated using the growing perpetuity formula: PV = C / (r - g), where C is the initial cash flow, r is the discount rate, and g is the growth rate. The discount rate is the weighted average cost of capital (WACC), which is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc). Given the debt-equity ratio of 1/3, E/V = 0.75 and D/V = 0.25. Substituting the given values, WACC = 0.75 * 16% + 0.25 * 10% * (1 - 0.35) = 13.25%. Using the growing perpetuity formula: PV = $40,000 / (0.1325 - 0.02) = $343,938.

A Company Has a Project with an Initial After-Tax Cash