Question

Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over four years using the straight-line method. The new cars are expected to generate $145,000 per year in earnings before taxes and depreciation for four years. The company is entirely financed by equity and has a 35 percent tax rate. The required return on the company’s unlevered equity is 13 percent, and the new fleet will not change the risk of the company.

a. What is the maximum price that the company should be willing to pay for the new fleet of cars if it remains an all-equity company?

b. Suppose the company can purchase the fleet of cars for $310,000. Additionally, assume the company can issue $240,000 of four-year, 7 percent debt to finance the project. All principal will be repaid in one balloon payment at the end of the fourth year. What is the adjusted present value (APV) of the project?

Answer 1

Answer - A

Tax	35%
No of cars	25
RR of return	13%
Cash flow	145,000
Dep	36,250
Tax	38,063
Cash flow after tax	70,688
Required Profit	9,189
Expected Price of the car	79,877

Answer - B

Calculations per car over 4 years
Required Captial	310,000
Equity	70,000	22.6% (% of cap)
Debt	240,000	77.4% (% of cap)
Interest Payment	67,200	7% X 240000*4
Tax benefit	43,680	Interest X 1-35%
Tax	50,820
Dep	(310,000)
Net Cash flow(Profit)	151,980
APV	$134,496	excel formula