Question

Fitzgerald Industries has a new project available that requires an initial investment of $5.1 million. The project will provide unlevered cash flows of $855,000 per year for the next 20 years. The company will finance the project with a debt-value ratio of .4. The company’s bonds have a YTM of 7.6 percent. The companies with operations comparable to this project have unlevered betas of 1.04, .92, 1.19, and 1.14. The risk-free rate is 4.2 percent and the market risk premium is 6.7 percent. The tax rate is 25 percent. |

What is the NPV of this project? |

Answer #1

Average beta =( 1.04 + 0.92 + 1.19 + 1.14)/4 = 1.0725

Cost of equity (K_{e})= R_{f} + Beta
× ( Market risk premium)

K_{e} = 4.2 + 1.0725 ( 6.7 )

K_{e} = 11.38575 %

WACC (Weighted average cost of capital ) = YTM after tax × debt value ratio + Cost of equity × (1- debt value ratio)

7.6 (1- .25)×0.4 + 11.38575 × 0.6 = 2.28 + 6.83145

WACC = 9.11145%

Present value of cash inflows = $855,000 × annuity factor at 9.11145 % for 20 years.

= $855,000 × 9.057 = $7,743,735

Present value of cash outflows = $ 5,100,000

Net present value of the project = Present value of cash inflows - Present value of cash outflows

=$ 7,743,735 - $ 5,100,000

NPV of the project = $ 2,643,735

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