Sunny Inc. is trying to decide whether investing in Project A is a good idea. This project will last 5 years and will not exist after that. Any salvage value will be considered as an additional cash flow to be added to the 5th year’s free cash flow. The project requires a $1,000,000 initial investment (today) and has the following projected free cash flows. The project is expected to have a salvage value of $200,000 (at the end of 5th year)

Year 1:$300,000

Year 2:$350,000

Year 3: Nothing

Year 4: $450,000

Year 5:$250,000

Sunny Inc provides the additional information:

D/E ratio: 0.7

Tax Rate: 20%

Most recent bond with a face value of $1000 sold for $950. This bond pays yearly coupon payments and the coupon rate is 6%. The bond has a remaining maturity of 15 years.

The beta for Sunny Inc. is 2. The S&P 500 has an expected return of 12% and the t-bill is 3%.

Q1) Please calculate the Cost of Debt (not taking taxes into consideration)

Q2) Please calculate the Cost of Equity (using the CAPM method)

Q3) Please calculate WACC

Q4) Please calculate NPV (remember to include the salvage value as part of the 5th year’s cash flow)

Q5) Please calculate IRR

Q6) Is this a good investment for Sunny Inc.? Why or why not?