Caribbean, Inc. is considering a new investment opportunity. The project requires an initial outlay of $525,000 and is expected to bring in a $75,000 cash inflow at the end of the first year. After the first year, annual cash flows from the project are forecasted to grow at a constant rate of 5% until the end of the fifth year and to remain constant forever thereafter. The company currently has a target debt-to-equity ratio of .40, but the industry that the company operates in has a debt-to-equity ratio of .25. The industry average beta is 1.2, the market risk premium is 7%, and the risk-free rate is 5%. Assume that all the companies in the industry can issue debt at the risk-free rate and the corporate tax rate is 40%. Assuming that the project will be financed at Caribbean’s target debt-to-equity ratio, should the company invest in the project?
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Caribbean, Inc. is considering a new investment opportunity. The project requires an initial outlay of $525,000 and is expected to bring in a $75,000
cash inflow at the end of the first year. After the first year, annual cash flows from the project areforecasted to grow at a constant rate of 5% until the end of the fifth year and to remain constant forever thereafter.The company currently has a target debt-to-equity ratio of .40, but the industry that the company operates in has a debt-to-equity ratio of .25. The industry average beta is 1.2, the market risk premium is 7%, and the risk-free rate is 5%. Assume that all the companies in the industry can issue debt at the risk-free rate and the corporate tax rate is 40%.
Assuming that the project will be financed at Caribbean’s target debt-to-equity ratio, should the company invest in the project?
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