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Assume a company with 30% debt and 70% equity capital structure is considering a project that requires initial investment of $1,000,000. The project's net operating cash flow for the first year is $50,000 and it grows at 15%, 12%, and 10% in subsequent three years. After that it grows at a constant 5% annual rate into perpetuity. The company's cost of debt is 8% and its cost of equity is 14%. Its marginal tax rate is 30%.
Problem a) Should this project be accepted assuming the company uses the same capital structure to finance it?
Problem b) Holding other things, the same, what perpetual growth rate after year 4 will result in zero NPV for the project?
Problem c) Assume 5% perpetual growth rate after year 4. Assume the company wants to finance this project with 50% debt and 50% equity. In that case both the costs of debt and equity will increase. New cost of debt will be 10%. Will the project be acceptable in this case?
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