Question

Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .40, but the industry target debt–equity ratio is .35. The industry average beta is 1.2. The market risk premium is 7 percent, and the risk-free rate is 5 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 40 percent. The project requires an initial outlay of $675,000 and is expected to result in a $95,000 cash inflow at the end of the first year. The project will be financed at Blue Angel’s target debt–equity ratio. Annual cash flows from the project will grow at a constant rate of 5 percent until the end of the fifth year and remain constant forever thereafter.

      

Calculate the NPV of the project. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

    

NPV

$

Answer 1

Levered beta = Unlevered beta (1+ (1-t) (Debt/Equity))
1.2=	Unlevered beta * (1+(1-40%)*35%)
1.2=	Unlevered beta * 1.21
Unlevered Beta=	1.2/1.21
Unlevered Beta=	0.991735537
Company Beta with 40% debt equity ratio
Beta=	0.991736 * (1+(1-40%)*40%)
Beta=	1.22975264
WACC=	Risk free rate + Beta * Market risk premium
WACC=	5%+1.229753*7%
WACC=	13.61%
Year	Cash flow	PV factor	Present Values
1	95,000	0.880	83,619.40
2	99,750	0.775	77,282.25
3	104,738	0.682	71,425.37
4	109,974	0.600	66,012.36
5	115,473	0.528	61,009.58
5	848,442	0.528	448,269.84
		Total PV	807,618.81
Current Dividend	115,473
Rate of return	13.61%
Growth Rate	0.00%
PV of future cash flows beyond year 5
	=Current cash flow*(1+Growth rate)/(Rate of return-Growth Rate)
	= 115473/(0.1361-0)
	848,442
Total PV	807,619
Initial cost	(675,000)
NPV	132,619