Question

Fitzgerald Industries has a new project available that requires an initial investment of $4.9 million. The project will provide unlevered cash flows of $846,000 per year for the next 20 years. The company will finance the project with a debt-value ratio of .35. The company's bonds have a YTM of 6.7 percent. The companies with operations comparable to this project have unlevered betas of 1.13, 1.06, 1.28, and 1.23. The risk-free rate is 4.1 percent and the market risk premium is 6.7 percent. The tax rate is 21 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) X Answer is complete but not entirely correct. NPV $ 1,503,120.20 (X

Correct answer will be thumbed up. Thank you!

Answer 1

WACC calculation:

Average asset beta for similar projects = (1.13 + 1.06 + 1.28 + 1.23)/4 = 1.175

Weights: D/V = 0.35, so E/V = 1 - 0.35 = 0.65

D/E = (D/V)/(E/V) = 0.35/0.65 = 53.85%

Using this asset beta to find the equity beta for the project: Equity beta = asset beta*[1 -(1-Tax rate)*D/E ratio]

= 1.175*[1 - (1-21%)*53.85%] = 1.675

Cost of equity (ke) using CAPM = risk-free rate + (beta*market risk premium)

= 4.10% + (1.675*6.70%) = 15.32%

After-tax cost of debt (kd) = cost of debt*(1- tax rate) = 6.70%*(1-21%) = 5.29%

WACC = (E/V*ke) + (D/V*kd)

= (65%*15.32%) + (35%*5.29%) = 11.81%

Present Value of cash flows from the project: PMT = 846,000; N = 20; rate = 11.81%, CPT PV.

PV = 6,394,587.82

NPV of the project = -Initial investment + PV of cash flows

= -4,900,000 + 6,394,587.82

= 1,494,587.82