Reference no: EM132406757

Sundae Inc. is deciding whether to undertake a new project. The project is expected to be riskier than the firm's current operations. For cost of capital estimation management wants to use the subjective approach and add 4 percent to its weighted average cost of capital of the firm. The new project is expected to generate free cash flow of $900,000 by the end of the first year, and the cash flows are projected to grow at a rate of 3 percent per year thereafter. It requires an initial investment of $9 million. The current capital structure of the firm is as follows:

Debt:

one-year annual-coupon bond with coupon rate of 2 percent, 100,000 shares outstanding, par value of $2,000, selling for 100 percent of par. Common stock: 1,100,000 shares outstanding, selling for $90 per share; on the balance sheet the stockholders' equity is $6 million; the beta is 1.1. Market: 5 percent market risk premium and 6 percent risk-free rate.  

The corporate tax rate is 21 percent. Answer the following questions.

a. The pre-tax cost of debt of the firm is %. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

b. The cost of equity of the firm is  %.(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)  

c. The debt/value ratio used in the calculation of the weighted average cost of capital of the firm is  %. The corresponding equity/value ratio is  %. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)  

d. The weighted average cost of capital of the firm is  %. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)    

e. The cost of capital of the project is  %. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)    

f. The net present value (NPV) of the new project is. (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)