The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decided to add an additional 1.2 percent to the company's overall cost of capital when evaluating this project. The project has an initial cash outlay of $63,000 and projected cash inflows of $19,000 in Year 1, $34,000 in Year 2, and $28,000 in Year 3. The firm uses 33 percent debt and 67 percent common stock as its capital structure. The company's cost of equity is 13.8 percent while the aftertax cost of debt for the firm is 5.7 percent. What is the projected net present value of the new project?

Question

Quizplus · Accepted Answer

1. Calculate the WACC with the additional 1.2 percent risk premium:
WACC = (0.33 x 5.7%) x (1 - 0.35) + (0.67 x 13.8%) = 10.37%
2. Calculate the present value of cash inflows:
PV1 = $19,000 / (1 + 10.37%)^1 = $16,784.98
PV2 = $34,000 / (1 + 10.37%)^2 = $25,991.95
PV3 = $28,000 / (1 + 10.37%)^3 = $20,187.25
3. Calculate the net present value:
NPV = PV1 + PV2 + PV3 - $63,000 = $16,784.98 + $25,991.95 + $20,187.25 - $63,000 = $618.18
Therefore, the projected net present value of the new project is $618, which is best represented by choice B.

The Bakery Is Considering a New Project It Considers to Be