Question

You are the owner of a large data-services firm and are deciding on the purchase of a new hardware cooling system that you expect will yield $233,300 in cost-savings per year for the next 15 years. The installation of this cooling system will cost $3,000,000.

3. Suppose that you decide to finance the purchase of this system through a loan from the bank. The bank is willing to loan this money over an 8 year term at an interest rate of 4% per year.

a. Using a 70/30 debt-to-equity ratio, what is the NPV of this project?

i. (hint) calculate the yearly payment using excel function “PMT”

b. How does the NPV of this project change if a larger portion is financed through equity (e.g. debt-to-equity ratio of 60/40)? Why?

Answer 1

	Per yr earning	233,300.00
	Annual rate	4%
	One time outflow	3,000,000.00
	Financed by: (70/30)
	Debt	2,100,000.00		PMT (70/30 Debt-equity ratio)	-311,908	($311,908.45)
	Equity	900,000.00
	Case 2: Financed by: (60/40)			PMT 60/40 Debt-equity ratio)	-267350.0977	($267,350.10)
	Debt	1,800,000.00
	Equity	1,200,000.00
Case 1	Year	Cashflows		Case 2	Year	Cashflows
	0	-900000			0	(1,200,000.00)
	1	-78608.4473			1	-34050.09768
	2	-78608.4473			2	-34050.09768
	3	-78608.4473			3	-34050.09768
	4	-78608.4473			4	-34050.09768
	5	-78608.4473			5	-34050.09768
	6	-78608.4473			6	-34050.09768
	7	-78608.4473			7	-34050.09768
	8	-78608.4473			8	-34050.09768
	9	233,300			9	233,300
	10	233,300			10	233,300
	11	233,300			11	233,300
	12	233,300			12	233,300
	13	233,300			13	233,300
	14	233,300			14	233,300
	15	233,300			15	233,300
	NPV	($919,651.91)			NPV	($1,208,512.35)