Muller, Inc., manufacturer of cardboard boxes, is considering taking on a new line of quality stationery, a related but very different field than cardboard boxes. Management has prepared a, six-year forecast for the project planning to reevaluate the venture after that time. The forecast anticipates that the project will cost $2 million to start after which it will generate $500,000 in each of the next six years. To be conservative a $200,000 shut down cost at the end of the sixth year has also be forecast. Muller's beta is 1.2, but Nugent Paper, a rival stationery manufacturer that does nothing else, is known to have a beta of 1.6. The return on an average stock is 9%, and the risk free rate is 5%. Muller's cost of capital is 8%.
a. What is the NPV of the stationery project if Muller uses the traditional cost of capital method for calculating NPV?
b. Assume that Nugent Paper is a pure play company for Muller's project. What is the NPV of the project using Nugent Paper and the pure play method?
c. What should Muller do? Why?
$(000)

Question

Muller, Inc., manufacturer of cardboard boxes, is considering taking on a new line of quality stationery, a related but very different field than cardboard boxes. Management has prepared a, six-year forecast for the project planning to reevaluate the venture after that time. The forecast anticipates that the project will cost $2 million to start after which it will generate $500,000 in each of the next six years. To be conservative a $200,000 shut down cost at the end of the sixth year has also be forecast. Muller's beta is 1.2, but Nugent Paper, a rival stationery manufacturer that does nothing else, is known to have a beta of 1.6. The return on an average stock is 9%, and the risk free rate is 5%. Muller's cost of capital is 8%.
a.	What is the NPV of the stationery project if Muller uses the traditional cost of capital method for calculating NPV?
b.	Assume that Nugent Paper is a pure play company for Muller's project. What is the NPV of the project using Nugent Paper and the pure play method?
c.	What should Muller do? Why?
 $(000)

Quizplus · Accepted Answer

The Answer of Muller, Inc., manufacturer of cardboard boxes, is considering taking on a new line of quality stationery, a related but very different field than cardboard boxes. Management has prepared a, six-year forecast for the project planning to reevaluate the venture after that time. The forecast anticipates that the project will cost $2 million to start after which it will generate $500,000 in each of the next six years. To be conservative a $200,000 shut down cost at the end of the sixth year has also be forecast. Muller's beta is 1.2, but Nugent Paper, a rival stationery manufacturer that does nothing else, is known to have a beta of 1.6. The return on an average stock is 9%, and the risk free rate is 5%. Muller's cost of capital is 8%.
a.	What is the NPV of the stationery project if Muller uses the traditional cost of capital method for calculating NPV?
b.	Assume that Nugent Paper is a pure play company for Muller's project. What is the NPV of the project using Nugent Paper and the pure play method?
c.	What should Muller do? Why?
 $(000)