Homework Answers
7). cost of capital = 4.2321% (option b)
| Life (n) | 10 | |
| Cost of capital (k) | 4.2321% | |
| Initial investment (a) | (10,00,000) | |
| Cash flow/year (cf) | 1,00,000 | |
| PV(k, n, cf) | PV of annual cash flow (b) | 8,01,798.70 |
| Liquidation value (lv) | 3,00,000 | |
| PV(k, n, 0, lv) | PV of Liquidation ('c) | 1,98,201.30 |
| (a+b+c) | Total NPV | (0.00) |
8). WACC = 15.12% (option c)
Weight of debt (wd) = 0.4; weight of equity (we) = 0.6
Cost of debt = 20%
After-tax cost of debt (kd) = cost of debt*(1-tax rate) = 20%*(1-40%) = 12%
Cost of equity (ke) = 7% + 1.7*6% = 17.2%
WACC = (wd*kd) + (we*ke) = (0.4*12%)+(0.6*17.2%) = 15.12%
9). Option b - A risk neutral investor would be looking for an investment with the highest return, regardless of the risk, with that investment.
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