Question

# Fitzgerald Industries has a new project available that requires an initial investment of \$5.1 million. The...

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?

The unlevered beta of the firm will be the average of the unlevered betas. Hence, unlevered beta = (1.04 + 0.92 + 1.19 + 1.14)/4 = 1.0725. Now assuming that the debt has beta = 0, the levered beta will be = Unlevered beta/equity percentage = 1.0725/0.6 = 1.7875. Now, we use CAPM to calculate cost of equity.

Re = Rf + Beta x (Rm-Rf) = 4.2 + 1.7875 x 6.7 = 16.17625%. The cost of debt is the YTM = 7.6% (before-tax). Hence, WACC = Rd x D/(D+E) x (1-T) + Re x E/(D+E) = 7.6 x 0.4 x 0.75 + 16.17625 x 0.6 = 11.98575%.

So, now the NPV equation will be:

NPV = -5.1 + 0.855 x (1/1.1198 + 1.1198^2 + ... + 1/1.1198^20) = \$1.294389 million.