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 $845,000 per year for the next 20 years. The company will finance the project with a debt-value ratio of .25. The company’s bonds have a YTM of 6.1 percent. The companies with operations comparable to this project have unlevered betas of 1.20, 1.13, 1.35, and 1.30. The risk-free rate is 3.5 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

In this case we would first calculate WACC of project
Average beta (Unlevered)	(1.20+1.13+1.35+1.30)/4
Average beta (Unlevered)	1.25
Debt equity ratio	Debt/Equity
Debt equity ratio	0.25/(1-0.25)
Debt equity ratio	0.333333333
Beta (levered)	(1+(1-tax rate)(Debt/equity))*Beta(unlevered)
Beta (levered)	(1+(1-0.25)(0.33333))*Beta(unlevered)
Beta (levered)	(1+(0.75*0.3333))*1.25
Beta (levered)	1.56
Calculation of cost of equity using CAPM model
Cost of equity (Ke)	Risk free rate + Beta*Market risk premium
Cost of equity (Ke)	0.035 + 1.56*0.067
Cost of equity (Ke)	13.97%
After tax cost of debt	4.58%	6.1%*(1-0.25)
WACC	Cost of debt*Weight of debt + Cost of equity*Weight of equity
WACC	(0.0458*0.25)+(0.1397*0.75)
WACC	11.62%
Net present value	Present value of cash inflow - Present value of cash outflow
Net present value	845000*((1-(1.01162^-20))/0.1162)-5300000
Net present value	(845000*7.650809)-5300000
Net present value	$1,164,933.89