A project generates unlevered (after-tax) cash flows of $16 million every year for 3 years. The investment is $36 million. The firm has a target debt ratio (D/V) of 45%. Preferred stock will be used for 15% of the investment amount and retained earnings will be used for the rest. The firms current bonds have 3 years left to maturity, a coupon rate of 8.5% with annual coupons, a face value of $1000. The price is listed at $106. The before-tax cost on any new bonds will be the same as the yield to maturity on the current bonds. Preferred stock has a dividend of $3.20 with a price of $38. Issue costs on preferred stock are $1.20 per share. To estimate the cost of retained earnings, the firm expects to pay a dividend of $3.60 per share next period. The growth rate is 8.5%. The current stock price is $60. The tax rate is 25%. Use the weighted average cost of capital (WACC) to find the net present value (NPV) of the project. For the WACC, carry work out to 4 decimal points. Should the project be accepted or not? Explain As per the data Total investment = $48000000 Debt = 45%X$48000000= $21600000 Equity (Preferred stock) =$ 3600000 Retained earnings = $ 22800000 Cost of Debt (Kd) YTM = (1000x7%)+(1000-980) 5 = 7.47% 1000+980 2 Post tax cost of debt = 7.4747(1-2.5)= 5.61% Cost of preference stock = Dividend/price-issue cost = 5/42-2 = 12.5% Cost of retained earnings=Rf +(betaxRp) = 4%+(1.2x10%)=16% WACC =(21600000/48000000)x5.61%+(3600000/48000000x12.5%)+(22800000/48000000x16%) =11.06% NPV OF Project= $20000000x(PVIFA,11%,4Y)-$48000000=$14048000 Accept the project Explanation for step 1 since NPV positive accept what I don't understand is why the investment is taken as 48 m while in the question it gives 36m . and how are these "Equity (Preferred stock) =$ 3600000 Retained earnings = $ 22800000" derived?