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. Given this information, what is the NPV of this project?

Explanation / Answer

Average Industrial beta = (1.15+1.08+1.30+1.25)/4

= 1.195

Ke = Rf + Beta* (Rm - Rf)

= 3.80% + 1.195*7 (Rm - Rf = Market risk premium)

= 12.165%

Kd = 6.80%(1-0.34)

= 4.488%

WACC = 4.488*0.40 + 12.165%*0.60)

= 9.09%

Computation of Net Present value

Initial Cash outflow (A) = $4500000

Present value of Cash inflows (675000*9.070) (B) = $6122250 (PVAF(1-20)@9.09 = 9.070)

NPV (B-A) = $1622250

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