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 six years using the straight-line method. The new cars are expected to generate $160,000 per year in earnings before taxes and depreciation for six years. The company is entirely financed by equity and has a 40 percent tax rate. The required return on the company’s unlevered equity is 11 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? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  

Maximum price

$

  

b.

Suppose the company can purchase the fleet of cars for $465,000. Additionally, assume the company can issue $375,000 of six-year, 7 percent debt to finance the project. All principal will be repaid in one balloon payment at the end of the sixth year. What is the adjusted present value (APV) of the project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  

APV

$

Answer 1

Provided Information

Car	25
Cash Flow(EBT)	1,60,000
Life	6
TR	40
Ke	11%
Type	All Equity Co

1.Maximum Price Payable

Maximum price payable for the additional fleet would be NPV of cash inflows from fleet

NPV Calc	Non variable	Variable(X)
EBT	160000
-Dep		-4.166666667
Tax @40%	64000	-1.666666667
PAT	96000	-2.5
Dep		4.166666667
Cash Flow	96000	1.666666667
Yearly Cash Flow	96000+1.66666666666667X
PVAF(11%,6 Years)	4.23054
Present Value of Cash Inflow	406131.84	7.0509
	406131.84+7.05090000000001X
PV of Cash outflow	25X

Solving Equation:

For Maximum Payment PVCOF=PVCIF
406131.84+7.05090000000001X=25X
406131=17.9491
X=22626.86
=22627 per Car

2.

		Weight/Calculation
Cash Outflow	465000
Additional Debt @ 7%	375000	0.806451613
Payable	End of 6th Year
Equity @ 11%	90000	0.193548387
WACC	7.77	0.806452*7+.193548*11
Depreciation	465000/6	77500
Calculation of APV
Particulars	Cash Flow
EBT	160000
Interest	26250
Dep	77500
EBT	56250
Tax @40%	22500
EAT	33750
Dep	77500
Cash Flow	111250
PVAF(7.77,6)	4.65531
(1)	517903.2375
Loan Repayment	375000
PVF(7.77,6)	0.63828
(2)	239355
	278548.24