Question
Suppose Green Gables Inc. is considering opening another office. The expansion will cost $50,000 and is expected to generate after-tax cash flows of $10,000 per
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Suppose Green Gables Inc. is considering opening another office. The expansion will cost $50,000 and is expected to generate after-tax cash flows of $10,000 per year in perpetuity. The firm has a target debt/equity ratio of .50. New equity has a flotation cost of 10% and a required return of 15%, while new debt costs 5% to issue and has a required return of 10%. The firm has a tax rate of 34%. Assume this project will not alter the risk of the firm and flotation costs are expensed.
a. Calculate the WACC b. Calculate the weighted average flotation costs
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c. Calculate the NPV of the project.
Suppose Green Gables Inc. is considering opening another office. The expansion will cost $50,000 and is expected to generate after-tax cash flows of $10,000 per year in perpetuity. The firm has a target debt/equity ratio of .50. New equity has a flotation cost of 10% and a required return of 15%, while new debt costs 5% to issue and has a required return of 10%. The firm has a tax rate of 34%. Assume this project will not alter the risk of the firm and flotation costs are expensed.
a. Calculate the WACC b. Calculate the weighted average flotation costs
c. Calculate the NPV of the project.
This is not clear to me. Can you more detail? I don' t understand difference between WACC and weighted average flotation costs. I don't know how to make NPV of the project. also, why this is $50,000/(1-.0833)= $54,543.47 and $10,000/.122 = 81,967.21?
a) D/E = 5 Therefore when Debt = .50 Equity = 1 Wo= .5/1.5= .3333 W=1/1.5=6667 Cost of Debt Rp = 10% Cost of Common Re = 15% WACC = (-3333)(.10)(1-34) + (-6667)(.15) =.122 or 12.2% b) Flotation Costs for Debt = 5% Flotation Costs for new Common = 10% Since the problem doesn't mention that firm has sufficient internal equity available to finance the project, they will have to issue new common shares. Weighted average flotation cost (fa) = .3333(5%) +.6667 (10%) = 8.33% Net Present Value of the project: Step 1: Initial investment: Cost of the asset Flotation Costs: -$50,000 Total amount that must be raised: $50,000/(1-.0833)=$54,543.47 Flotation Costs = $54,543.47 - $50,000 =$4,543.47 After-tax flotation costs = $4,543.47(1-34) = Total initial investment -2.998.69 -$52,998.69 (2) Present Value of After-tax cash flows $10,000/.122 = 81,967.21 NPV = -$52,998.69+ $81,967.21 = $28,968.52Step by Step Solution
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