The Simpson Corp. is planning construction of a new plant. The initial cost of the investment is $5 million. Efficiencies from the new plant are expected to reduce costs by $620,000 forever. The corporation has a total value of $400 million and has outstanding debt of $150 million. What is the NPV of the project if the firm has an after tax cost of debt of 5% and a cost equity of 8%?

Question

Quizplus · Accepted Answer

The NPV is calculated by discounting the perpetual savings of $620,000 at the firm's weighted average cost of capital (WACC). The WACC is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc), where E is equity, D is debt, V is total value, Re is cost of equity, Rd is cost of debt, and Tc is the tax rate. Assuming no taxes, WACC = (250/400)*8% + (150/400)*5% = 6.25%. The NPV = $620,000 / 0.0625 - $5,000,000 = $4,018,181.