A. Calculating the WACC Cost of Debt = .072a x (1 - .30) = .0504 Cost of Equity (using CAPM) = .05 + 1.33(.03) = .0899
Weighting these individual costs for their weight of all capital: .75 (.0899) + .25 (.0504) = .0674 + .0126 = .08 = 8%
a
Pre tax cost of debt is equal to $LIBOR * 180 basis points. This is 5.4% + 1.8%, which is 7.2%.
B. NPV Calculation The calculations for the NPV are in the following table: $m July 1
2015
2016
2017
2018
2019
2020
680
900
900
750
320
0
Direct costs (60%)
(408)
(540)
(540)
(450)
(192)
0
Redeployment of Labor
(150)
(150)
0
0
0
0
Investment
(800)
Revenue
Taxable cash flow
122
Tax at 30% Depreciation Tax Shield
b
48.0
210
360
300
128
0
(36.6)
(63)
(108)
(90)
(38.4)
48.0
48.0
48.0
48.0
Net cash on sale of equipment
7.0
After tax cash flow
(800)
170.0
221.4
345.0
240.0
86.0
(31.4)
Discount @ 8%
1.000
0.926
0.857
0.794
0.735
0.681
0.630
(800.0)
157.4
189.8
273.9
176.4
58.5
(19.8)
PV NPV b
$36.2
This is calculated by multiplying the depreciation expense by the tax rate. Because it is a 5-year useful life, the annual depreciation under straight line is $160,000. This $160,000 is a deductible expense for tax purposes, reducing the amount that is paid in taxes by $48,000 ($160,000 * .3). This tax payment savings is treated as a cash inflow.
