Question

Neon Corporation’s stock returns have a covariance with the market portfolio of .0495. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk premium is 8.3 percent. The company has bonds outstanding with a total market value of $55.08 million and a yield to maturity of 7.3 percent. The company also has 4.58 million shares of common stock outstanding, each selling for $28. The company’s CEO considers the current debt–equity ratio optimal. The corporate tax rate is 34 percent, and Treasury bills currently yield 4.2 percent. The company is considering the purchase of additional equipment that would cost $42.08 million. The expected unlevered cash flows from the equipment are $11.88 million per year for five years. Purchasing the equipment will not change the risk level of the company. Calculate the NPV of the project. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

Answer 1

Covariance (stock,market)	0.0495
Std deviation of stock	20%
Variance(Stock)	0.04	square of std deviation
Beta of stock	1.2375	Covariance/variance
Market risk premium	8.30%
Risk free rate	4.20%
Using CAPM cost of equity
Cost of equity	14.47%	Risk free rate +Beta*Market risk premium
Yield to maturiy	7.30%
Debt market value	55.08	million
No of share	4.58	million
Share price	28	per share
Equity value	128.24	Million
WACC	12.32%	using WACC formula
Year	0	1	2	3	4	5
Unlevered cash flow		11.88	11.88	11.88	11.88	11.88
Tax@34%		4.0392	4.0392	4.0392	4.0392	4.0392
Net cash flow		7.8408	7.8408	7.8408	7.8408	7.8408
NPV	$28.04	Million	Using rate as WACC