WACC Assumptions The risk of the project is identical to the risk of the firms existing assets The project will be financed in the same way(same D: E)as the firm as a whole
WACC Assumptions • The risk of the project is identical to the risk of the firm’s existing assets. • The project will be financed in the same way (same D:E) as the firm as a whole
WACC Method The after-tax Wacc will be less than the firm's opportunity cost of capital because of the tax advantages of debt financing Discount the unlevered cash flows(UCFs) at the after-tax Wacc to get the nPv
WACC Method • The after-tax WACC will be less than the firm’s opportunity cost of capital because of the tax advantages of debt financing. • Discount the unlevered cash flows (UCFs) at the after-tax WACC to get the NPV
Example Cash inflows =$1 200 000 · Costs=77.5%ofsa|es Initial cost =$960 000 Tax rate 30% Opportunity cost of capital =21% Cost of debt =12% Cost of equity= 23.7% Debt-to-value ratio=0.30
Example • Cash inflows = $1 200 000 • Costs = 77.5% of sales • Initial cost = $960 000 • Tax rate = 30% • Opportunity cost of capital = 21% • Cost of debt = 12% • Cost of equity = 23.7% • Debt-to-value ratio = 0.30
WACC Solution Step Calculate unlevered cash flow(UCF) Cash inflows $1200000 Cash costs(77.5%) 930000 Operating income 270000 Tax(30%) 81000 UCF $189000
WACC Solution Step 1 – Calculate unlevered cash flow (UCF) Cash inflows $1 200 000 Cash costs (77.5%) 930 000 Operating income 270 000 Tax (30%) 81 000 UCF $ 189 000
WACC Solution Step 2- Calculate after-tax WAcc 70 30 k ×0.237 012×(1-0.30) 100 '*lI 100 0.1659+0.0252 =0.1911or19.11
WACC Solution Step 2 – Calculate after-tax WACC ( ) 0.1911or 19.11% 0.1659 0.0252 0.12 1- 0.30 100 30 0.237 100 70 ka = = + + =