Question
Leader Inc. is considering a project that needs $400,000 initial cash outlay and produces cash flows of $150,000 per year for the next 4 years.The
Leader Inc. is considering a project that needs $400,000 initial cash outlay and produces cash flows of $150,000 per year for the next 4 years.The applicable tax rate is 35%, before-tax cost of debt is 6.5%, and current price of Leaders share being $36 per share.The expected dividend next year is $2.00 per share, with an annual growth rate of 5%.Assume : Leader finances the project with 50% debt & 50% equity capital; floating costs (listing costs of Leaders shares) are 4.5% of the equity amount; appropriate discount rate for the project is the Weighted Average Cost of Capital (WACC).Floating costs can be accounted for by either one of the methods below :
(I)As a % of the amount of equity raised and take it as a lump sum deductible at the beginning of the project, or
(II)To be adjusted in the cost of equity (Hint : the share price is first adjusted downward by the floating costs before calculating the cost of equity)
a.Using Method (I), calculate the Net Present Value (NPV) of the project.
b.Discuss how the result of this method differs from the result obtained if we use Method (II).Explain which method should be more appropriate for project evaluation.
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