Blue Angel, Inc., a private firm in the holiday gift industry, is considering a
ID: 2752772 • 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 .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.