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):
|
Year
|
1
|
2
|
3
|
4
|
5
|
|
Revenues
|
$6
|
$6.5
|
$9.5
|
$11
|
$11.5
|
|
Costs
|
$2
|
$3
|
$3.4
|
$9.4
|
$11.4
|
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