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

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 .45, but the industry target debt–equity ratio is .40. The industry average beta is 1.30. The market risk premium is 7 percent, and the risk-free rate is 5 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 $688,000 and is expected to result in a $108,000 cash inflow at the end of the first year. The project will be financed at Blue Angel’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 final answer to 2 decimal places. (e.g., 32.16))

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 .40. The industry average beta is 1.30. The market risk premium is 7 percent, and the risk-free rate is 5 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 $688,000 and is expected to result in a $108,000 cash inflow at the end of the first year. The project will be financed at Blue Angel’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.

Explanation / Answer

Blue Angel Inc Derails Risk free rate=Rf= 5% Market Risk Premium=Rm-Rf= 7% Industry avg beta=                      1.30 Equity Cost=Rf+(Rm-Rf)*beta =0.05+0.07*1.3 14.10% Cost of equity = 14.10% Cost of debt 5% Tax rate 34% Post tax cost of debt = 3.30% Debt Equity ratio                      0.45 Required investment=               688,000 Debt =               213,517 Equity =               474,483 WACC=0.69*0.1410+0.31*0.0330= 10.75% NPV calculation Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment            (688,000) Cash flow                         108,000          113,400          119,070       125,024             131,275                        1,221,160 ( =131275/10.75% the PV of entire cah flow) Dicount factor @10.75%                            1                           0.9029            0.8153            0.7362         0.6647               0.6002                              0.5419 PV of cash flows            (688,000)                           97,517            92,454            87,654         83,103               78,788                           661,775 NPV $    413,290.76 Actual result may vary with the given result to you due to difference in discounting factor digits used, Here 4 digit factor used for accuracy.

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.