Reference no: EM131981295
Scones and More Inc. (SAM), is considering investing in a large baking facility. Capital expenditure today would be $20,000,000, which could be depreciated straight line over 5 years. New revenues and costs (both pretax) generated by the plant over the next 5 years would be (in millions):
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Year
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1
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2
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3
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4
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5
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Revenues
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$6
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$6.5
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$9.5
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$11
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$11.5
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Costs
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$2
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$3
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$3.4
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$9.4
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$11.4
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The firm faces a tax rate of 35% and beyond year 5, assume that net cash flows will stay constant in perpetuity. Suppose the beta of this project is 1.1, the market risk premium is 3.7%, and the risk-free rate is 3.5%. SAM has current debt and equity values of $10 million and $70 million, respectively.
This new project would allow financing of $5 million of risk-free debt (paying the risk-free rate) and $15 million of equity initially.
At year 5, an additional $2 million of debt would be issued to pay some of that year's costs, and debt would then be maintained at $12 million in perpetuity.
Perform an APV analysis of the project to determine its NPV
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