Question

BE is considering a $10 million project that will last five years, implying straight-line depreciation per year of $2 million. The cash revenues less cash expenses per year are $3,500,000. The corporate tax bracket is 30 percent. The cost of unlevered equity is 20 percent. Please value the project by APV method under two case below.
(1) Case I: BE can obtain a five-year, nonamortizing loan for $7,500,000 after flotation costs at the risk-free rate of 10 percent. Flotation costs are fees paid when stock or debt is issued. BE is informed that flotation costs will be 1 percent of the gross proceeds of its loan.
(2) Case II: BE can obtain a five-year, subsidized loan for $7,500,000.

Answer 1

Question Summary
Project Cost	$ 10 Million
Cash Revenue less expense	$ 3.5 Million	Per Year
Depreciation	$ 2 Million	Per Year
Unlevered cost of equity	20%
Project life	5 Years
Tax Rate	30%

						($'s in Millions)
Years	Revenue less expense	Depreciation	Revenue after Depreciation	Tax expense	Revenue after tax	Cash Revenue after tax
1	3.5	2	1.5	0.45	1.05	3.05
2	3.5	2	1.5	0.45	1.05	3.05
3	3.5	2	1.5	0.45	1.05	3.05
4	3.5	2	1.5	0.45	1.05	3.05
5	3.5	2	1.5	0.45	1.05	3.05

			($'s in Millions)
Years	Cash Revenue after tax	Present value factor @20%	Present value
1	3.05	0.8333	2.54
2	3.05	0.6944	2.12
3	3.05	0.5787	1.77
4	3.05	0.4823	1.47
5	3.05	0.4019	1.23
Present value of Cash inflows			9.12
Less:	Present value of Cash outflows		10
Net present value			(0.88)