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Suppose that Caterpillar Incorporated is considering a new line of construction graders. To launch the new...

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Finance

Suppose that Caterpillar Incorporated is considering a new lineof construction graders. To launch the new product, Caterpillarwill have to invest $200.00 million. The target capital structurefor Caterpillar is 45.00% debt and 55.00% equity (marketvalues).

The CFO for the company believes that new debt can be issuedwith an 8.00% annual coupon rate. After reviewing the company’sbeta, the CFO also believes that common stockholders require a15.00% return for the new investment.

The company projects an annual after-tax cash flow of $65.00million for the new project. The company has a marginal tax rate of35.00%, and expects to run the project for 10.00 years.

What is the NPV for the project?(express in millions)

Answer & Explanation Solved by verified expert
3.8 Ratings (342 Votes)

Net present value is equal to present value of cash inflow less present value of cash outflow
Calculation of Weighted average cost of capital to be used at discount rate to calculate NPV
After tax cost of debt is 8%*(1-0.35) 5.20%
WACC Weight of equity*Cost of equity + Weight of debt*Cost of debt
WACC (0.55*0.15)+(0.45*0.052)
WACC 10.59%
Calculation of net present value
Year Cash flow Discount factor @ 10.59% Present Value (Cash inflow*Discount factor)
0 -200 1.00000 1/(1.1059^0) -200.000
1 65 0.90424 1/(1.1059^1) 58.776
2 65 0.81765 1/(1.1059^2) 53.147
3 65 0.73935 1/(1.1059^3) 48.058
4 65 0.66855 1/(1.1059^4) 43.456
5 65 0.60453 1/(1.1059^5) 39.295
6 65 0.54664 1/(1.1059^6) 35.532
7 65 0.49430 1/(1.1059^7) 32.129
8 65 0.44696 1/(1.1059^8) 29.053
9 65 0.40416 1/(1.1059^9) 26.271
10 65 0.36546 1/(1.1059^10) 23.755
NPV 189.471
The net present value of the project is $189.471 million

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Suppose that Caterpillar Incorporated is considering a new lineof construction graders. To launch the new product, Caterpillarwill have to invest $200.00 million. The target capital structurefor Caterpillar is 45.00% debt and 55.00% equity (marketvalues).The CFO for the company believes that new debt can be issuedwith an 8.00% annual coupon rate. After reviewing the company’sbeta, the CFO also believes that common stockholders require a15.00% return for the new investment.The company projects an annual after-tax cash flow of $65.00million for the new project. The company has a marginal tax rate of35.00%, and expects to run the project for 10.00 years.What is the NPV for the project?(express in millions)

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