Question

Fitzgerald Industries has a new project available that requires an initial investment of $5.3 million. The project will provide unlevered cash flows of $853,000 per year for the next 20 years. The company will finance the project with a debt-value ratio of .3. The company’s bonds have a YTM of 7.4 percent. The companies with operations comparable to this project have unlevered betas of 1.06, .94, 1.21, and 1.16. The risk-free rate is 4.4 percent and the market risk premium is 6.3 percent. The tax rate is 23 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

Before tax cost of debt=YTM of bonds=7.4%

After tax cost of debt=7.4%*(1-Tax rate%)=7.4%*(1-23%)=5.70%

Cost of equity=risk free rate +(Unlevered Beta*market risk premium)

To calculate beta, we have to average the competitors similar projects betas. It comes around 1.09

Cost of equity=4.4%+(1.09*6.3%)=11.28%

WACC=(Weightage of equity*cost of equity)+(Weighatge of debt*after tax cost of debt)

Given debt value ratio=0.3 that means debt/equity rato=0.3

Weight of debt=0.3/(0.3+1)=0.3/1.3=23.08%

Weight of equity=1/1.3=76.92%

WACC=(76.92%*11.28%)+(23.08%*5.70%)

WACC=10%

The unlevered cashflows are $853,000 per year for next 20 years.

NPV(Rate, Year 1 to Year20 unlevered cashflows)-investment cost

NPV(10%,Year 1 to Year 20 cash flows)-$5,300,000

NPV=$1,965,044.89