Question
In: Accounting
Consider a project to produce solar water heaters. It requires a $10 million investment and offers...
Consider a project to produce solar water heaters. It requires a
$10 million investment and offers a level after-tax cash flow of
$1.69 million per year for 10 years. The opportunity cost of
capital is 11.25%, which reflects the project’s business
risk.
a. Suppose the project is financed with $7 million
of debt and $3 million of equity. The interest rate is 7.25% and
the marginal tax rate is 21%. An equal amount of the debt will be
repaid in each year of the project's life.
Calculate APV. (Enter your answer in dollars, not millions
of dollars. Do not round intermediate calculations.
Round your answer to the nearest whole
number.)
b. If the firm incurs issue costs of $600,000 to raise the $3 million of required equity, what will be the APV? (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number. Negative amount shoud be indicated by a minus sign.)
Solutions
Expert Solution
a.
PV of cash flow unlevered:-
=Annual cash flow * PVIFA(11.25%, 10 years)
=1690000 * 5.828
=$9849320
Interest tax shield:-
| Opening Balance | Interest rate | Interest | Principal | Closing balance | Tax rate | Interest tax shield(Interest * Tax rate) | PV Factor(11.25%,10 years) | PV of interest tax shield |
| 7000000 | 7.25% | 507500 | 700000 | 6300000 | 21% | 106575 | 0.89888 | 95798.136 |
| 6300000 | 7.25% | 456750 | 700000 | 5600000 | 21% | 95917.5 | 0.80798 | 77499.422 |
| 5600000 | 7.25% | 406000 | 700000 | 4900000 | 21% | 85260 | 0.72627 | 61921.78 |
| 4900000 | 7.25% | 355250 | 700000 | 4200000 | 21% | 74602.5 | 0.65283 | 48702.75 |
| 4200000 | 7.25% | 304500 | 700000 | 3500000 | 21% | 63945 | 0.58681 | 37523.565 |
| 3500000 | 7.25% | 253750 | 700000 | 2800000 | 21% | 53287.5 | 0.52747 | 28107.558 |
| 2800000 | 7.25% | 203000 | 700000 | 2100000 | 21% | 42630 | 0.47413 | 20212.162 |
| 2100000 | 7.25% | 152250 | 700000 | 1400000 | 21% | 31972.5 | 0.42619 | 13626.36 |
| 1400000 | 7.25% | 101500 | 700000 | 700000 | 21% | 21315 | 0.38309 | 8165.5634 |
| 700000 | 7.25% | 50750 | 700000 | 0 | 21% | 10657.5 | 0.34435 | 3669.9101 |
| Total | 5.828 | 395227.21 |
PV of interest tax shield = 395227.21
Adjusted Present Value = PV of cash flow unlevered + Net effect of debt - Initial outlay
= 9849320 + 395227.21 - 10000000
= $244547
b.
Issue costs = 600000
Adjusted Present Value = PV of cash flow unlevered + Net effect of debt - Initial outlay - issue costs
= 9849320 + 395227.21 - 10000000 - 600000
= $ -355453
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