Question

MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt-equity ratio of 65 percent and the tax rate is 22 percent. The required return on the firm’s levered equity is 12 percent. The company is planning to expand its production capacity. The equipment to be purchased is expected to generate the following unlevered cash flows:

  

Year	Cash Flow
0	−$19,800,000
1	5,880,000
2	9,680,000
3	8,980,000

  

The company has arranged a debt issue of $9.84 million to partially finance the expansion. Under the loan, the company would pay interest of 7 percent at the end of each year on the outstanding balance at the beginning of the year. The company also would make year-end principal payments of $3,280,000 per year, completely retiring the issue by the end of the third year.

  

Calculate the APV of the project. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

Answer 1

1]	The first step is to find out the cost of unlevered equity.
	Rl = Ru+(Ru-Rd)*(1-t)*D/E
	Substituting values, we have
	0.12 = Ru+(Ru-0.07)*(1-22%)*0.65
	Solving for Ru
	0.12 = Ru+(Ru-0.07)*(1-22%)*0.65
	0.12 = Ru+0.507*Ru-0.03549
	0.15549 = 1.507*Ru
	Ru = 0.15549/1.507 =	10.32%
2]	The second step is to find the NPV of the all equity firm.
	NPV [all equity] = -19800000+5880000/1.1032+9680000/1.1032^2+8980000/1.1032^3 =	$    1,71,872.72
3]	The next step is to find the NPV of the financing side
	effects.	0	1	2	3
	Beginning balance of loan		$     98,40,000	$       65,60,000	$     32,80,000
	Interest paid at 7%		$        6,88,800	$         4,59,200	$       2,29,600
	Principal repayment		$     32,80,000	$       32,80,000	$     32,80,000
	Cash flows from debt:
	Receipt of loan	$        98,40,000
	After tax interest = Interest*(1-22%)		$      -5,37,264	$       -3,58,176	$      -1,79,088
	Principal repayment		$    -32,80,000	$     -32,80,000	$   -32,80,000
	Cash flows from debt	$        98,40,000	$    -38,17,264	$     -36,38,176	$   -34,59,088
	PVIF at 7%	1	0.93458	0.87344	0.81630
	PV at 7%	$        98,40,000	$    -35,67,536	$     -31,77,724	$   -28,23,646
	NPV of financing side effects	$    2,71,093.54
4]	APV = NPV [Unlevered+NPV of financing side effects] = 171872.72+271093.54 =	$    4,42,966.26