Question

Dorman Industries has a new project available that requires an initial investment of $6.5 million. The project will provide unlevered cash flows of $875,000 per year for the next 20 years. The company will finance the project with a debt-to-value ratio of .4. The company’s bonds have a YTM of 5.9 percent. The companies with operations comparable to this project have unlevered betas of 1.35, 1.28, 1.50, and 1.45. The risk-free rate is 2.9 percent, and the market risk premium is 6.1 percent. The company has a tax rate of 34 percent. What is the NPV of this project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Initial investment= $6500,000

WACC:

Cost of debt = 5.9%*(1-tax)

=5.9%*(1-0.34) = 3.894%

Cost of equity= Rf+ Beta * Risk premium

Beta= Average of all 4 betas= (1.35+1.28+1.5+1.45)/4= 1.395

Cost of equity= 2.9%+ 1.395*6.1%= 11.4095%

WACC= 0.4*3.894% + 0.6*11.4095%= 8.4%

Unlevered cash flows= 875000

Less Interest= 3.894%*0.4*6500000 = 101244

Levered cash flows=773756

PV of cash flows= C*(1-1/(1+r)^n)/ r

=773756*(1-1/(1+0.084 )^20)/0.084

=7375945.57

NPV= PV of cash flows- Initial cost

=7375945.57- 6500000

=$ 875945.57