connect Hunter Casselberry FINA 6341 fall 2017: fall 2017 A FINANCE chap 18 hw i

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connect Hunter Casselberry FINA 6341 fall 2017: fall 2017 A FINANCE chap 18 hw instructions I help Question 5 (of 6) Save & Exit Submit 5· 10.00 points Dorman Industries has a new project available that requires an initial investment of $5.1 million. The project will provide unlevered cash flows of S735,000 per year for the next 20 years. The company will finance the project with a debt-to-value ratio of.4. The company's bonds have a YTM of 6.6 percent. The companies with operations comparable to this project have unlevered betas of 1.21, 1.14, 1.36, and 1.31. The risk-free rate is 3.6 percent, and the market risk premium is 6.8 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, e.g., 1,234,567 Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV References eBook & Resources Worksheet Difficulty: 2 Intermediate Section: 18.7 Beta and Leverage k my work

Explanation / Answer

unlevered betas of companies with projects comparable to the project = 1.21, 1.14, 1.36, 1.31

Average unlevered beta= 1.255

Debt / value ratio = 0.4

Debt/Equity ratio = 0.666667

Since the project will be levered, we need to calculate the levered beta, which is:

Levered = Beta unlevered firm Beta *[1 + (1 Tax)(Debt/Equity)]

Levered = [1 + (1 .34)(.6667)]1.255

Levered = 1.807

Now we can use the Capital Asset Pricing Model to determine the cost of equity.

The Capital Asset Pricing Model is: RS = RF + (RM RF)

RS = 3.6% + 1.807(6.8%)

RS = 15.89%

Now, we can calculate the company’s WACC, which is: RWACC = [B/(B + S)](1 TC)RB + [S/(B + S)]RS

RWACC = 0.40*(1 .34)(.066) + 0.60(0.1589)

RWACC = .1128 or 11.28%

Finally, we can use the WACC to discount the unlevered cash flows, which gives us an NPV of:

NPV = $5,100,000 + $735,000(PVIFA 11.28%,20)

NPV = $5,100,000 + $735,000*7.8196892

= $ 647471.6

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