a)
To determine: The cost of capital of the project.
Introduction:
The difference between the present value of cash inflows and the present value of
a)
Explanation of Solution
Given information:
The initial investment for the project is $83,600,000 and it creates an annual
It is given that the IRR must be less than 20%. However, it is given as 20%. Thus, the NPV will become zero.
Hence, Company S should discount the cash flows at less than 20%, as the NPV is positive.
b)
To determine: The cost of capital of the firm.
Introduction:
The difference between the present value of cash inflows and the present value of cash outflows for a particular period is known as the Net Present value. Cost of capital is the cost of long term financing of the firm.
b)
Explanation of Solution
Given information:
The initial investment for the project is $83,600,000 and it generates an annual cash inflow of $18,800,000 for 12 years. The project NPV is $66,000,000 and the IRR is 20%.
Explanation:
When the initial investment I0, annual cash flow (AC), rate of interest r, and the time period n is given NPV can be calculated using the below equation:
By trial and error method let us assume the cost of capital to be 0.07.
When substituting 11%, NPV is $65,722,502.38. The NPV is nearly equal to the given NPV $66,000,000. Thus, cost of capital of the firm is 7% (approximately).
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