21st Century Cat is a film producing company which is contemplating the production of a new film. They estimate that:
The production of the film will require an investment of £300,000 in year 0.
The distribution will generate a stream of cash flows equal to £200,000 in year 1, and £100,000 in each of years 2 and 3.
In year 3, the producer will sell the rights to a tv broadcaster for £90,000.
Distribution costs will be £75,000 in year 1, and £50,000 in each of years 2 and 3.
Due to regulation aimed at promoting cinema, all income generated by the project is tax-free.
a. The company's financial experts say that the appropriate discount factor for the project is 10%. Calculate the NPV using this discount factor and determine whether the project should be funded.
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0
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1
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2
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3
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Initial Inv
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300
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Revenues
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200
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100
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190
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Costs
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75
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50
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50
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Cash Flows
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-300
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125
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50
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140
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Discount factor at 10% rate
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1.1
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1
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0.909091
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0.826446
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0.751315
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Discounted Cash flows
|
-300
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113.6364
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41.32231
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105.1841
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NPV at 10%
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-39.8573
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b. Assume now that the company has a debt/equity ratio equal to one. The company's bonds yield a 6% return, the company's beta is equal to 0.5, the market risk premium is 5%, while the risk-free rate is 3%. Calculate the NPV of the project with the new data.
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Rcapm
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0.055
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Rwacc
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0.0575
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Discount factor at 5.75% rate
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1.0575
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1
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0.945626
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0.894209
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0.845588
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Discounted Cash flows
|
-300
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118.2033
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44.71047
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118.3823
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NPV at 5.75%
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-18.7039
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