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 $5.8 million. The project will provide unlevered cash flows of $805,000 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 1.28, 1.21, 1.43, and 1.38. The risk-free rate is 3.8 percent, and the market risk premium is 7 percent. The company has a tax rate of 40 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))

  NPV

$   

Stackhouse Industries has a new project available that requires an initial investment of $5.8 million. The project will provide unlevered cash flows of $805,000 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 1.28, 1.21, 1.43, and 1.38. The risk-free rate is 3.8 percent, and the market risk premium is 7 percent. The company has a tax rate of 40 percent.

Explanation / Answer

Average Unlevered Beta = (1.28+1.21+1.43+1.38) / 4 = 1.325

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

= 1.325 x [1 + (1-0.40) x 0.40) ]

= 1.64

Cost of Equity = Risk free rate + (Market Risk Premium x Beta)

= 3.8 + (7x1.64)

= 15.28%

Cost of Debt = 6.8% x (1-0.4)

= 4.08%

WACC = [Weight of Debt x Cost of Debt] + [Weight of Equity x Cost of Equity]

= [0.40 x 4.08] + [0.60 x 15.28]

= 10.8%

Levered Cash flows = Unlevered cash flows (1-tax)

= 805000 (1-0.40)

= $483000

Present Value of Cash inflows = [483000 x 8.069] + Tax saving on depreciation

= 3897327 + [290000 x 0.40]

= $4013327

NPV = Present Value of Cash inflows - Present Value of cash outlows

= 4013327 - 5800000

= -$1786673

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