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 .35, but the industry target debt-equity ratio is .30. The industry average beta is 1.90. The market risk premium is 6 percent, and the risk-free rate is 4 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 34 percent. The project requires an initial outlay of $682,000 and is expected to result in a $102,000 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 4 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.) NPV

Answer 1

Ra= Rfr+[Ba*(Rm-Rfr)]

Where:

Ra = Expected return on a security
Rrf = Risk-free rate
Ba = Beta of the security
Rm = Expected return of the market

Note: “Risk Premium” = (Rm – Rrf)

Ra= 4+[1.9*(6-4)

Ra= 7.8%

Interest
682000*.35=	238700
238700/5=	47740

Present value of perpetuity formula

PV = C / R

Where:

PV = Present value

C = Amount of continuous cash payment

r = Interest rate or yield

	1	2	3	4	5	total
Cash inflow	102000	106080	110323.2	114736.1	119325.6
Less: interest	47740	47740	47740	47740	47740
	54260	58340	62583.2	66996.13	71585.57
tax 34%	18448.4	19835.6	21278.29	22778.68	24339.09
EAT	35811.6	38504.4	41304.91	44217.44	47246.48
Dicount at 7.8%	0.928	0.861	0.798	0.74	0.687
PV of cashflow	33233.16	33152.29	32961.32	32720.91	32458.33	164526
PV of cashflow in perpetuity					32458.83/.078=	416132.4
total inflow						580658.5
outflow						682000
NPV						-101342