Beta Industries is considering a project with an initial cost of $6.9 million. The project will produce cash inflows of $1.52 million a year for seven years. The firm uses the subjective approach to assign discount rates to projects. For this project, the subjective adjustment is 2.2 percent. The firm has a pretax cost of debt of 9.1 percent and a cost of equity of 17.7 percent. The debt-equity ratio is .57 and the tax rate is 34 percent. What is the net present value of the project

-$6.98 million

Explanation:

For computing the net present value first we have to find out the RATE which is shown below:

= Pre tax cost of debt × (1 - tax rate) × debt equity ratio ÷ (1 + debt equity ratio) + cost of equity × 1 ÷ (1 + debt equity ratio) + subjective adjustment

= 9.1% × (1 - 0.34) × 0.57 ÷ 1.57 + 17.7% × 1 ÷ 1.57 + 2.2%

= 15.65%

Now the net present value is

               (in $ millions)                                            (in $ millions)

YearCash flowsDiscount rate 15.65%PV of cash inflows  

0            -69                  1                               -69  (A)

1            15.2           0.8646779075               13.14

2            15.2           0.7476678837              11.36

3            15.2           0.6464919012               9.83

4            15.2            0.5590072643               8.50

5            15.2            0.4833612316              7.35

6             15.2           0.4179517783              6.35

7             15.2           0.361393669             5.49

Present value                                        62.02   (B)

Net present value                                -6.98   (B - A)

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