You are helping a friend make projections for a 5-year project. The equipment needed for the project costs 5 million, and according to the tax authority, is depreciated using the straight-line method over five years. The pre-tax salvage value of the equipment at the end of the five years is 1 million. The purchase of the equipment is made in year 0 (now).

 The expected revenues each year from production are expected to be 2 million in year 1, then 2.1 million in year 2, then 2.2 million in year 3, and so on (100,000 increments until year 5). The expected sales growth is an extrapolation from past data on average industry sector sales. The labor required to operate the equipment will cost 500,000 every year, starting in year 1. Wages are not expected to change over time due to strict employment regulations. The marginal tax rate is 27%.

 Working capital each year is maintained at 20% of next year sales (and is fully recovered at the end; i.e. the level of working capital is 0 in year 5). Thus in year 0, the level of working capital will be 20% of sales in year 1 (assume there was no working capital prior to year 0).

 The cost of financing for the project can be inferred from the following data. The projected beta of equity for the project is 1.2, and the firm is planning to maintain a constant debt-to-equity ratio (in market values) of 0.4. Using expert forecasts for stock market returns, you find that the annual expected return for the entire market is 8% for the next 5 years, and that the risk-free rate will be projected to remain at 4% over the entire life of the project.

 The cost of debt is unknown, however, you have the following information concerning the current market interest rates for corporate bonds of various ratings. Firms of a given credit rating can borrow at an associated cost of debt, as long as they achieve an interest coverage ratio that is above the minimum required threshold as per the table below:

Please calculate the NPV of this project. 

Credit Rating	AAA   AA    A    BBB    BB   B
rd(%) Minimum Interest Coverage (EBIT / Interest Payments) Probability of default (%)	5        2      6     7         8     9    45     10      7      5        3     2    0.5    0.7   1.0   2.0     3.0   5.0

Answer rating: 100% (QA)

To calculate the net present value NPV of the project we need to estimate the cash flows for each year and discount them to their present value Heres how we can calculate the NPV 1 Calculate the annua... View the full answer