Question
A two-year project Delta will generate after-tax cash inflow of $3,009,913 at the end of the first year and $2,769,991.67 at the end of the
A two-year project Delta will generate after-tax cash inflow of $3,009,913 at the end of the first year and $2,769,991.67 at the end of the second year. Your company currently has borrowing worth $149,815,110.40 for which the company is paying 7.4% per year as cost of debt, and the shareholders of the company have invested a total of $73,789,532; and they generally want a return of 15% per year. Corporate tax rate is at 37%. The project is somewhat riskier than the usual project your company undertakes, and the management therefore uses the subjective approach and applies an adjustment factor of +2.5% to the cost of capital for the project.
a) If your company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should your company use to discount the project's cash flows? Show calculation
b) Under what circumstances in terms of the project cost should the company take on the project Delta? Apply NPV rule in your analysis.
c) Discuss how your finding in part b) would go wrong if the rate in part a) is used to evaluate the project.
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