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? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

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