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Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project....

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 .45, but the industry target debt-equity ratio is .50. The industry average beta is 1.10. The market risk premium is 6.9 percent and the risk-free rate is 4.5 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 23 percent. The project requires an initial outlay of $825,000 and is expected to result in a $101,000 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 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 answer to 2 decimal places, e.g., 32.16.)

riad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $201 million. The equipment will be fully depreciated using the straight-line method over its economic life of five years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $27.8 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 24 percent. The required rate of return for the project under all-equity financing is 14 percent. The pretax cost of debt for the joint partnership is 8.3 percent. To encourage investment in the country’s infrastructure, the U.S. government will subsidize the project with a $135 million, 15-year loan at an interest rate of 4.7 percent per year. All principal will be repaid in one balloon payment at the end of Year 15.

  

What is the adjusted present value of this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

Solutions

Expert Solution

Blue Angel Inc
Target Debt to Equity Ratio 0.45
Industry Debt to Equity Ratio 50.0%
Industry Average Beta 110.0%
Tax Rate 23.0%
Unlevered Beta =Levered beta/(1+(1-tax rate)*D/E)
Industry unlevered beta 0.79 =1.1/(1+(1-23%)*0.5)
Levering beta for Blue Angel Inc
Levered Beta =Unevered beta*(1+(1-tax rate)*D/E)
Levered Beta of Blue Angels 1.07
Risk Free Rate 4.50%
Market Risk Premium 6.90%
Cost of Equity 11.9% =4.5%+1.07*6.90%
Cost of Debt 4.50% =Risk free rate
E/ (D+E) 68.97%
D/(D+E) 31.03%
Cost of Capital (WACC) 9.3% =D/(D+E)*Cost of Debt*(1-Tax%) + E/(D+E)*Cost of Equity
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial Outlay -825000
Yearly cash flows 101000 106050 111353 116920 122766
Terminal Value (Do/R) 1324657
Cash Flows -825000 101000 106050 111353 116920 1447423
NPV USD 4,14,473.83

Answer

Question 2

  • APV is the NPV of a project or company if financed solely by equity plus the present value of financing benefits.
  • APV shows an investor the benefit of tax shields from tax-deductible interest payments.
  • It is best used for leverage transactions, such as leveraged buyouts, but is more of an academic calculation.
Raid Corporation
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 20
Initial Investment -201000000
EBITDA 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000
Depreciation -40200000 -40200000 -40200000 -40200000 -40200000
EBIT -12400000 -12400000 -12400000 -12400000 -12400000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000
Interest for unlevered firm 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
EBT -12400000 -12400000 -12400000 -12400000 -12400000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000 27800000
Tax 0 0 0 0 0 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000 -6672000
Net Income -12400000 -12400000 -12400000 -12400000 -12400000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000
Add Back Depreciation 40200000 40200000 40200000 40200000 40200000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Operating Cash Flows 27800000 27800000 27800000 27800000 27800000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000
Total Cash Flows -201000000 27800000 27800000 27800000 27800000 27800000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000 21128000
Cost of equity financing 14%
NPV USD -3,34,74,545.16
Benefits of Loan
Loan Amount 135000000
Yearly interest rate -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000 -6345000
Tax Shield Benefit 0 0 0 0 0 1522800 1522800 1522800 1522800 1522800 1522800 1522800 1522800 1522800 1522800
Baloon Repayment -135000000
All debt cash flows 135000000 -6345000 -6345000 -6345000 -6345000 -6345000 -4822200 -4822200 -4822200 -4822200 -4822200 -4822200 -4822200 -4822200 -4822200 -139822200
NPV of Debt (Net Effect of Debt) USD 90,57,917.84
Adjusted Present Value = NPV for unlevered or all equity structure + Net Effect of Debt
Adjusted Present Value USD -2,44,16,627.32

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