Question

Fitzgerald Industries has a new project available that requires an initial investment of $5.2 million. The project will provide unlevered cash flows of $839,000 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 6 percent. The companies with operations comparable to this project have unlevered betas of 1.19, 1.12, 1.34, and 1.29. The risk-free rate is 3.4 percent and the market risk premium is 6.6 percent. The tax rate is 24 percent.

  

What is the NPV of this project?

Answer 1

Unlevered Beta = (1.19 + 1.12 + 1.34 + 1.29) / 4 = 4.94 / 4 = 1.235

Beta levered = Beta unlevered * (1 + (1 - tax rate)) * Debt/Equity
= 1.235 * (1 + (1 - 0.24) * (40/60))
= 1.86

Cost of equity = Risk free rate + beta * market risk premium
= 3.4% + 1.86 * 6.6%
= 3.4% + 12.28%
= 15.68%

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt * (1-tax rate) * Weight of debt)
= (15.68% * 0.6) + (6% * (1 - 0.24) * 0.4)
= 9.4085% + 1.824%
= 11.23%

NPV = Present value of cash flows - initial investment
= ($839,000 * PVIFA @11.23%, 20 Years) - $5,200,000
= ($839,000 * 8.056592) - $5,200,000
= $6,759,480 - $5,200,000
= $1,559,480

NPV = $1,559,480

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