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 .65, but the industry target debt-equity ratio is .70. The industry average beta is 1.05. The market risk premium is 6.6 percent and the risk-free rate is 4.6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 25 percent. The project requires an initial outlay of $860,000 and is expected to result in a $108,000 cash inflow at the end of the first year. The project will be financed at the company’s target debt-equity ratio. Annual cash flows from the project will grow at a constant rate of 6 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 answer to 2 decimal places, e.g., 32.16.)

Answer 1

We have considered 6.6% as market risk premium (Rm-Rf). Answer may differ if someone consider it as market rate, as in that scenario market risk premium will come down to 2% (6.6%-4.6%).