Please show formulas and calculations and not just results and numbers, and explain rationale for answers. Whenever applicable, interest is compounded annually and payments occur at the end of the period. Face value for bonds is $1000.
A project generates net (after-tax) cash flows of $20 million every year for 4 years. The investment is $48 million. The tax rate is 40%. The firm has a target debt ratio (debt ratio = debt/value) of 45%. They intend to raise the funds to keep this target ratio. The firm’s current bonds have 5 years left to maturity, a coupon rate of 7% with annual coupons, a face value of $1000 and currently trade for $960. The (before-tax) cost on any new debt will be the same as the yield to maturity on the current bonds. For the equity, they will use $3,600,000 in preferred stock and the rest will be from retained earnings. The preferred stock has a dividend of $4 with a price of $42. Issue costs on preferred stock are $2. To estimate the cost of retained earnings, the firm has an equity beta of 1.2. The risk-free return is 4% and the market risk premium is 10%.
Use the weighted average cost of capital (WACC) to find the net present value (NPV) of the project.