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Question 370  capital budgeting, NPV, interest tax shield, WACC, CFFA

Project Data
Project life 2 yrs
Initial investment in equipment $600k
Depreciation of equipment per year $250k
Expected sale price of equipment at end of project $200k
Revenue per job $12k
Variable cost per job $4k
Quantity of jobs per year 120
Fixed costs per year, paid at the end of each year $100k
Interest expense in first year (at t=1) $16.091k
Interest expense in second year (at t=2) $9.711k
Tax rate 30%
Government treasury bond yield 5%
Bank loan debt yield 6%
Levered cost of equity 12.5%
Market portfolio return 10%
Beta of assets 1.24
Beta of levered equity 1.5
Firm's and project's debt-to-equity ratio 25%


  1. The project will require an immediate purchase of $50k of inventory, which will all be sold at cost when the project ends. Current liabilities are negligible so they can be ignored.


  • The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio. Note that interest expense is different in each year.
  • Thousands are represented by 'k' (kilo).
  • All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
  • All rates and cash flows are nominal. The inflation rate is 2% pa.
  • All rates are given as effective annual rates.
  • The 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

Copyright © 2014 Keith Woodward