Question

First and Ten Corporation's stock returns have a covariance with the market portfolio of 0461. The standard deviation of the returns on the market portfolio is 20 percent and the expected market risk premium is 7.2 percent. The company has bonds outstanding with a total market value of $55.9 million and a yield to maturity of 6.1 percent. The company also has 5.1 million shares of common stock outstanding, each selling for $42 The company's CEO considers the firm's current debt-equity ratio optimal. The corporate tax rate is 24 percent and Treasury bills currently yield 3.5 percent. The company is considering the purchase of additional equipment that would cost $53.5 million. The expected unlevered cash flows from the equipment are $17.75 million per year for 5 years. Purchasing the equipment will not change the risk level of the firm. Calculate the NPV of the 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) NPV

Answer 1

Market value WACC (Cost capital %xWeights) Market value Cost % structure Cost of equity 11.80%| $ 214,200,000 0.7930 9.36% 3.5%+(0.0461/0.2^2)*7.2% =5100000*42 4.64% $ 55,900,000 Debt (After tax cost) 0.96% 0.2070 6.1%* (1-24%) $ 270,100,000 Total 1.0000 Weighted average cost of capital (WACC) 10.32%

PVIF @ 10.32% Cash flow Present value Year O$ (53,500,000) 1 17,750,000 2 17,750,000 3$ 17,750,000 4 $17,750,000 5 17,750,000 1.0000 $ 0.9065 $ 0.8217 $ (53,500,000.00) 16,090,177.55 14,585,566.97 0.7449$ 13,221,654.21 0.6752 $ 0.6121 $ 11,985,282.47 10,864,525.24 $13,247,206.44 Net present value