3 XYZ expanding their business They need to invest 67000000

3. XYZ expanding their business. They need to invest $67,000,000 in order to do so. The Investment Bank recommends they raise the funds in the following manner: 60% equity financing-cost of equity 13%, and 40% debt financing, cost of debt 6% Preet expected to generate in year one 25 Million, in year two 40 Million and in year three 17 Million. Is the project worth doing or not?

Solution

We compute the NPV of the project to see whether it is viable or not.

First, we compute the discount rate or the Cost of capital -

Cost of capital = Cost of Equity x weight of equity + cost of debt x weight of debt = 13% x 60% + 6% x 40% = 10.20%

Now, we discount the cash flows using this rate. Present value of a cash flow can be computed as -

PV = Cash flow / (1 + r)ⁿ

where, r is the discount rate, n is the year to which it belongs

NPV = (-)Cost of project + [ Cash Flow in year 1 / (1 + r)¹ ] + [ Cash Flow in year 2 / (1 + r)² ] + [ Cash Flow in year 3 / (1 + r)³ ]

or, NPV = (-)$67,000,000 + [ $25,000,000 / (1 + 10.20%)¹ ] + [ $40,000,000 / (1 + 10.20%)² ] +[ $17,000,000 / (1 + 10.20%)³ ]

or, NPV = $1,326,930.1462 or $1,326,930.15

Since NPV is positive, the project is worth investing.