Blue Angel, Inc., a private firm in the holiday gift industry, is considering a
ID: 2738829 • Letter: B
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 .30, but the industry target debt–equity ratio is .25. The industry average beta is 1.40. The market risk premium is 8 percent, and the risk-free rate is 6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 35 percent. The project requires an initial outlay of $689,000 and is expected to result in a $109,000 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 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 final answer to 2 decimal places. (e.g., 32.16))
NPV $
Explanation / Answer
Cost of debt = 6% * (1 - 35%)
= 3.90%
Cost of equity = 6% + 1.40 * 8%
= 17.20%
WACC = 0.30 / 1.30 * 3.90% + 1.00 / 1.30 * 17.20%
= 14.13%
NPV = - $689,000 + $109,000 / (1 + 14.13%) + $109,000 * (1 + 6%) / (1 + 14.13%)2 + $109,000 * (1 + 6%)2 / (1 + 14.13%)3 + $109,000 * (1 + 6%)3 / (1 + 14.13%)4 + $109,000 * (1 + 6%)4 / (1 + 14.13%)5 + $109,000 * (1 + 6%)4 / [(1 + 14.13%)5 * 14.13%]
= $228,100.50