Hartley, Inc. needs to purchase equipment for its 2,000 drive-ins nationwide. The total cost of the equipment is $2 million. It is estimated that the after-tax cash inﬂows from the project will be
$210,000 annually in perpetuity. Hartley has a market value debt-to-assets ratio of 40%. The ﬁrm's
Cost of equity is 13%, its pre-tax cost of debt is 8%, and the ﬂotation costs of debt and equity are 2%
And 8%, respectively. The tax rate is 34%. Assume the project is of similar risk to the ﬁrm's existing
Operations.
Ignoring ﬂotation costs, what is the NPV of the proposed project?

Question

Quizplus · Accepted Answer

1. Calculate the after-tax cash flows: 
Annual cash inflows = $210,000 
Tax rate = 34% 
After-tax cash inflows = $210,000 * (1-0.34) = $138,600 per year

2. Calculate the weighted average cost of capital (WACC): 
Cost of equity = 13% 
Pre-tax cost of debt = 8% 
Market value debt-to-assets ratio = 40% 
Tax rate = 34% 
WACC = (0.6 * 0.13) + (0.4 * 0.08 * (1-0.34)) = 0.1068 or 10.68%

3. Calculate the NPV: 
NPV = - $2,000,000 + ($138,600 / 0.1068) = $119,072

Therefore, the NPV of the proposed project is $119,072, which is option D.