Parnassus Corporation plans to invest $150 million in a new generator that will produce free cash flows of $20 million per year in perpetuity. The firm is all equity financed, with an equity cost of capital of 10%.
a. What is the NPV of the project ignoring any costs of raising funds?
b. Suppose the firm will issue new equity to raise the $150 million, and has after-tax issuance costs equal to 8% of the proceeds. What is the NPV of the project including these issuance costs, assuming all future free cash flows generated by it will be paid out?
c. Suppose that instead of paying out the project’s future free cash flows, a substantial portion of these free cash flows will be retained and invested in other projects, reducing Parnassus’ required fundraising in the future. Specifically, suppose the firm will reinvest all free cash flows for the next 10 years, and then pay out the cash flows after that. If its issuance costs remain constant at 8%, what is the NPV of the project including issuance costs in this case?
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