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 $6.4 million. The project will provide unlevered cash flows of $865,000 per year for the next 20 years. The company will finance the project with a debt-to-value ratio of .3. The company's bonds have a YTM of 5.8 percent. The companies with operations comparable to this project have unlevered betas of 1.34, 1.27, 1.49, and 1.44. The risk-free rate is 2.8 percent, and the market riskpremium is 6 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.) NPV

Explanation / Answer

Average unlevered beta = (1.34 + 1.27 + 1.49 + 1.44) / 4 = 1.385

Levered beta for Dorman = Unlevered beta x (1 + (1 - tax) x D/E) = 1.385 x (1 + (1 - 40%) x 3/7) = 1.741

Cost of equity, ke = Rf + beta x MRP = 2.8% + 1.741 x 6% = 13.25%

WACC = wd x kd x (1 - tax) + we x ke

= 30% x 5.8% x (1 - 40%) + 70% x 13.25%

= 10.32%

PV of cash flows can be calculated using PV function

N = 20, PMT = 865,000, I/Y = 10.32%, FV = 0 => Compute PV = $7,206,205.23

NPV = 7,206,205.23 - 6,400,000 = $806,205.23

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