In: Finance

# Neon Corporation’s stock returns have a covariance with the market portfolio of .0455. The standard deviation...

 Neon Corporation’s stock returns have a covariance with the market portfolio of .0455. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk premium is 7.9 percent. The company has bonds outstanding with a total market value of $55.04 million and a yield to maturity of 6.9 percent. The company also has 4.54 million shares of common stock outstanding, each selling for$24. The company’s CEO considers the current debt–equity ratio optimal. The corporate tax rate is 40 percent, and Treasury bills currently yield 3.8 percent. The company is considering the purchase of additional equipment that would cost $42.04 million. The expected unlevered cash flows from the equipment are$11.84 million per year for five years. Purchasing the equipment will not change the risk level of the company.

 Calculate the NPV of the project.

## Solutions

##### Expert Solution

 Beta of company covariance between stock return and market return/ variance of market .0455/.04 1.14 Variance of market return square of standard deviation 20%^2 0.04 covariance between stock return & market return 0.0455 Required rate of return on equity Using CAPM risk free rate+(market risk premium)*beta 3.8+(7.9)*1.14 12.81 after tax cost of bonds YTM*(1-tax rate) 6.9*(1-.4) 4.14 WACC source Value Weight = Individual value/total Bonds 55.04 0.3356098 common stock 4.54*24 108.96 0.6643902 total 164 WACC = sum of weight* cost of source Year cash flow present value of cash flow = cash flow/(1+WACC)^n WACC = 10.22% 0 -42.04 -42.04 1 11.84 10.74215 2 11.84 9.746101 3 11.84 8.842407 4 11.84 8.022506 5 11.84 7.27863 NPV = sum of present value of cash flow 2.59 NPV is positive so it should be purchased

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