Question

Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 7.3 percent loan with gross proceeds of $5,250,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 1.1 percent of gross proceeds and will be amortized using a straight-line schedule over the 10-year life of the loan. The company has a tax rate of 34 percent, and the loan will not increase the risk of financial distress for the company.

  

a.	Calculate the net present value of the loan excluding flotation costs. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Net present value

$

  

b.	Calculate the net present value of the loan including flotation costs. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Net present value

$

Answer 1

If flotation costs are not taken into account, the net present value of a loan equals:

NPV_Loan = Gross Proceeds - After-tax PV of interest - After-tax PV of principal payments

NPV_Loan = 5,250,000 - 0.073 * (5,250,000) * (1 - 0.34) * PVIFA_(7.3%,10) - 5,250,000/1.073¹⁰

NPV_Loan = 5,250,000 - 0.073 * (5,250,000) * (1 - 0.34) * 6.9272 - 5,250,000/1.073¹⁰

NPV_Loan = 902,651.68

Part B

The flotation costs of the loan will be:

Flotation costs = 5,250,000 * (.011)

Flotation costs = 57,750

So, the annual flotation expense will be:

Annual flotation expense = 57,750 / 10

Annual flotation expense = 5,775

If flotation costs are taken into account, the net present value of a loan equals:

NPV_Loan = Proceeds net of flotation costs – After-tax PV of interest - After-tax PV of principal payments + Present value of the flotation cost tax shield

NPV_Loan = (5,250,000 - 57,750) - (0.073 * (5,250,000) * (1 - 0.34) * PVIFA_(7.3%,10) – 5,250,000/1.073¹⁰ + 5,775 * (0.34) * PVIFA_(7.3%,10)

NPV_Loan = 858,503.23