Determining the target debt-equity ratio

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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 .30, but the industry target debt-equity ratio is .25. The industry average beta is 1.10. The market risk premium is 6.2 percent and the risk-free rate is 3.8 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 21 percent. The project requires an initial outlay of $790,000 and is expected to result in a $94,000 cash inflow at the end of the first year. The project will be financed at the company's target debt-equity ratio. Annual cash flows from the project will grow at a constant rate of 4 percent until the end of the fifth year and remain constant forever thereafter.

Reference no: EM133057247

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