LongLegs, Inc. is an all-equity firm whose current business involves manufacturi
ID: 2648367 • Letter: L
Question
LongLegs, Inc. is an all-equity firm whose current business involves manufacturing and selling designer jeans. The company is blessed in that it operates in capital markets that are perfect, that is, there are no taxes or bankruptcy costs. The current weighted average cost of capital (WACC) of LongLegs, Inc. is 11.50%, and its equity beta is 2.00. LongLegs, Inc. is considering penetrating the wind energy business. The wind project requires a $10,000,000 investment at t = 0 and will yield $500,000 a year for the foreseeable future, starting a year from today (at t = 1). The manager of the new wind project realizes that he is only responsible for the production of electricity and that virtually all the risk is idiosyncratic; after all, wind just blows whenever it wants to. The risk free rate is 2.50%, the market risk premium (the average difference between the return on the market and the risk-free rate) is 4.50%, and the wind project will be financed with equity. What is the NPV of this project?
Explanation / Answer
Cost of Equity=Rf+beta(Market Risk Premium)
=2.5+2(4.5)
=11.5%
NPV=Present Value of Cash Inflow-Cash Outflow Present Value of cash inflow=Cash Inflow/wacc
=500000/.115-10000000
43,47,826-10000000
= $-5652174
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