Cost Management

You are evaluating a project that requires an investment of $90 today and provides a single cash flow of $115 for sure one year from now. You decide to use 100% debt financing, that is, you will borrow $90. The risk-free rate is 5% and the tax rate is 25%. Assume that the investment is fully depreciated at the end of the year, so without leverage you would owe taxes on the difference between the project cash flow and the investment, that is, $25.

 

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a. Calculate the NPV of this investment opportunity using the APV method.

b. Using your answer to part a, calculate the WACC of the project.

c. Verify that you get the same answer using the WACC method to calculate NPV.

d. Finally, show that flow-to-equity also correctly gives the NPV of this investment opportunity.

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