Dorman Industries has a new project available that requires an initial investmen

Question

Dorman Industries has a new project available that requires an initial investment of $5.3 million. The project will provide unlevered cash flows of $755,000 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 6.8 percent. The companies with operations comparable to this project have unlevered betas of 1.23, 1.16, 1.38, and 1.33. 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, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Dorman Industries has a new project available that requires an initial investment of $5.3 million. The project will provide unlevered cash flows of $755,000 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 6.8 percent. The companies with operations comparable to this project have unlevered betas of 1.23, 1.16, 1.38, and 1.33. 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 of Unlevered Beta will be Dorman Industries Unlevered Beta:

BUnlevered=(1.23+1.16+1.38+1.33)/4= 1.275

Now we have to lever this Beta based on capital structure of Dormant Industries:

BLevered=BUnlevered[1+(1-Tax Rate)×(Debt/Equity)]

           =1.275[1+(1-0.40)×(0.40/0.60)]

          =1.785

Now we will use the CAPM model to find the cost of equity:

=Risk Free Rate + BLevered(Market Risk Premium)

=3.80+1.785(7)

=16.295%

Now we have all the information to find WACC:

=Cost of Debt(1-Tax Rate)(Debt/Value)+Cost of Equity(Equity/Value)

=6.8(1-0.40)(0.40)+16.295(0.60)

=11.409%

Now we just need to find the NPV:

Time Period

Cash Flows

0

-5,300,000.00

1-20

755,000

WACC

11.4090%

Using the excel NPV function we get:

NPV=$ 498,153.46

Time Period

Cash Flows

0

-5,300,000.00

1-20

755,000

WACC

11.4090%

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.