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

The calculation of NPV requires the calculation of WACC or the discount rate. Similarly, the calculation of the WACC requires the calculation of the company beta. Thus, the levered beta of the company is calculated using the pure-play method so that the NPV can be determined. All the calculations have been done using Excel

NPV calculation:

Formulas: