You are planning to set up a travel agency called Stern Social Trek (SST) to arrange pleasure treks all around the world for Stern students, faculty, staff and their friends for the next three years. Today's date is 01/01/02. The office equipment for SST will be purchased today and costs $600,000. It is expected to last for three years. At the end of its life, the office equipment will have a salvage value of $200,000. For the office equipment, IRS rules prescribe straight line depreciation over three years.  For the year 2002, the average price of each trip is $1,494 and the average cost of providing it is $1,061. In addition to these costs, running the travel agency involves total labor costs of $124,000 per year. Revenues and costs occur at the end of a year and are expected to remain unchanged in 2003 and 2004. 

The rent, which is also paid at the end of a year, is expected to be $20,000 per year for each of the three years. SST is expected to sell 1,000 trips each year for the next three years (i.e., in 2002, 2003, & 2004).  The firm has a corporate tax rate of 35 percent. Taxes are paid at the end of each year. The return on assets for this type of project is 12 percent.

 

1. Provide a cash-flow table with the unlevered after-tax cash flows. The dates are: 1/1/2002, 12/31/2002, 12/31/2003, and 12/31/2004.

 

Calculate the NPV as of today assuming the firm is all-equity financed.

 

Calculate the NPV as of today assuming the firm has a constant debt-to-value ratio (D/V = D/(D+E) ) of 30%. The firm's cost of debt at this debt-to-value ratio is 6 percent. Use the WACC method.