Question

DTT Inc is considering an investment into another product line that is closely related to the firm's current business. The product line will require a $40 million investment in assets, all of which will be depreciated to zero (straight line) over the products expected 10 year life. The assets should have a salvage value of $3.5 million at the end of the project. The firm expects the investment to increase sales by $15 million per year and increase expenses by $6.8 million per year, starting 1 year from today. What is the WACC for DTT Inc, and the NPV of this project given the following additional information? DTT has a Debt/Equity ratio of 0.60 DTT has 1 debt issue outstanding with coupon rate of 12% and yield to maturity of 9.5% DTT equity has a beta = 1.31 The risk-free return is currently 3.5% and the expected return on the market portfolio is 12.5% DTT's marginal tax rate is 28%

Please attach a file that clearly shows calculations for (A) the WACC for DTT Inc., and (B) the NPV of the investment. Please highlight your final answers in red so I can find it easily!

Answer 1

Answers A and B:

Answers highlighted in red.

Kindly note in absence of rounding off instructions, WACC is not rounded off and same is used for calculation of WACC.

If WACC is rounded off NPV answer will differ a little.

(A) WACC: Given: Pre-tax Cost of debt Tax rate Risk Free Return Expected return on market portfolio Beta Debt Equity ratio 9.50% 28% 3.50% 1.31 0.60 Workings: Weight of debt Weight of Equity Cost of Equity 0.375 0.625 15.29% WACC 12.12125% B. NPV of the Investment: Year 1 to Year 10 Terminal Cash flow Year Investment in assets Year 0 ($40,000,000) Increase in sales Increase in expenses Depreciation EBIT Tax at 28% EAT Add back depreciation Operating cash flow $15,000,000 ($6,800,000) ($4,000,000) $4,200,000 ($1,176,000) $3,024,000 $4,000,000 $7,024,000 Salvage value net of tax $2,520,000 ($40,000,000) $2,520,000 $7,024,000 5.622289 Cash flows PV of $1 annuity for 10 years at WACC PV of $1 for 10 years at WACC PV of cash flows NPV 0.318508 $802,640.80 ($40,000,000)| $39,490,960.31 $293,601.11

The above excel with 'show formula' is as below (in 2 images):

1 (A) WACC: 2 3 Given: 4 Pre-tax Cost of debt 5 Tax rate 6 Risk Free Return Expected return on market portfolio 8 Beta 9 Debt Equity ratio 10 11 Workings: 12 Weight of debt 13 Weight of Equity 14 Cost of Equity 0.095 0.28 0.035 0.125 1.31 0.6 =B9/(1+B9) =1/(1+B9) =B6+B8*(B7-B6) 15 =B14*B13+B4*(1-B5)*B12 16 WACC 17

Year o Year 1 to Year 10 Terminal Cash flow -40000000 19 B. NPV of the Investment: 20 21 Year 22 Investment in assets 23 24 Increase in sales 25 Increase in expenses 26 Depreciation 27 EBIT 28 Tax at 28% 29 EAT 30 Add back depreciation 31 Operating cash flow 32 33 Salvage value net of tax 15000000 --6800000 =B22/10 =SUM(C24:C26) =C27*-B5 =C27+C28 --C26 =C29+C30 =3500000* (1-B5) 34 =B22 -D33 =C31 =(1-1/(1+B16)^10)/B16 35 Cash flows 36 PV of $1 annuity for 10 years at WACC 37 PV of $1 for 10 years at WACC 38 PV of cash flows 39 NPV 1=1/(1+B16)^10 =D35*D37 =B35 =C35*C36 =SUM(B38:D38) 40