Use the following information to answer the question(s)below.
Taggart Transcontinental is considering a $250 million investment to launch a new rail line.The project is expected to generate a free cash flow of $32 million per year,and its unlevered cost of capital is 8%.Taggart's corporate tax rate is 21%.Taggert has 4 million shares of stock outstanding.
-Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded by a cut in dividends.Assuming Taggart will incur a 2% (after-tax)underwriting fee on the new debt issue,the NPV of Taggart's new rail line is closest to:
A)$180 million.
B)$200 million.
C)$235 million.
D)$240 million.

Question

Quizplus · Accepted Answer

The correct answer is A. The NPV of the project is $180 million. The free cash flow is $32 million per year, and the unlevered cost of capital is 8%. The project will be funded with $150 million in debt and $100 million in equity. The after-tax cost of debt is 8% * (1 - 21%) = 6.32%. The WACC is (6.32% * 150 / 250) + (8% * 100 / 250) = 7.04%. The NPV is $32 million / 7.04% = $180 million.

Use the Following Information to Answer the Question(s)below