Question

Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 7.6 percent loan with gross proceeds of $6,400,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 2.7 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 23 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.)
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.)

    

Answer 1

a). Loan NPV (without flotation costs) = gross proceeds - Present Value (PV) of after-tax annual interest payments - Present Value of principal payment

Gross proceeds = 6,400,000

Annual interest payment = interest rate*gross proceeds = 7.6%*6,400,000 = 486,400

After-tax interest payment = 486,400*(1- tax rate) = 486,400*(1-23%) = 374,528

PV of after-tax interest payment: PMT = 374,528; N = 10; rate = 7.6%, CPT PV. PV = 2,559,093.14

PV of principal payment = gross proceeds/(1+7.6%)^10 = 6,400,000/(1+7.6%)^10 = 3,076,502.42

Loan NPV = 6,400,000 - 2,559,093.14 - 3,076,502.42 = 764,404.44

b). Loan NPV (with flotation costs) = Loan NPV (without flotation costs) - flotation costs + PV of the flotation tax shield

Flotation cost = 2.7%*gross proceeds = 2.7%*6,400,000 = 172,800

Annual amortization = flotation cost/term of the loan = 172,800/10 = 17,280

Annual tax shield = Tax rate*annual amortization = 23%*17,280 = 3,974.40

PV pf annual tax shield: PMT = 2,974.4; N = 10; rate = 7.6%, CPT PV. PV = 27,156.47

Loan NPV (with flotation costs) = 764,404.44 - 172,800 + 27,156.47 = 618,760.92