Stackhouse Industries has a new project available that requires an initial inves

Question

Stackhouse Industries has a new project available that requires an initial investment of $4.5 million. The project will provide unlevered cash flows of $675,000 per year for the next 20 years. The company will Finance the project with a debt-to-value ratio of .40. The company?s bonds have a YTM of 6.8 percent. The companies with operations comparable to this project have unlevered betas of 1.15, 1.08. 1.30, and 1.25. The risk-free rate is 3.8 percent, and the market risk premium is 7 percent. The company has a tax rate of 34 percent. What is the NPV of this project? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Answer:

Calculating the cost of debt = YTM * (1-tax)

= 6.8% * (1-.34)

= 4.49%

Calculating cost of equity

Average of beta = 1.15+1.08+1.30+1.25)/4

Beta = 1.195

Cost of equity = Risk free rate + Beta * market premium

= 3.8% + 1.195 * 7%

= 12.165%

Cost of capital = .40*4.49% + .60*12.165% = 9.095%

Calculating the present value of cash flows: = Cash flows * PVIFA

675000*9.067 = 6120280.226

NPV = Present value of cash flow - initial investment

= 6120280.226 - 4500000

= 1620280.23

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