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.