Question

MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt–equity ratio of 50% and is in the 40% tax bracket. The required return on the firm’s levered equity is 16%. The company is planning to expand its production capacity. The equipment to be purchased is expected to generate the unlevered cash flows given in the table below. The company has arranged a debt issue of $8.7 million to partially finance the expansion. Under the loan, the company would pay interest of 9% at the end of each year on the outstanding debt balance at the beginning of the year. The company would also make year-end principal payments of $2,900,000 per year, completely retiring the issue by the end of the third year. Use the adjusted present value (APV) method and find whether the company should proceed with the expansion or not?

Debt-equity ratio	0.50
Tax rate	40%
Cost of levered equity	16%
Year 0 cash flow	$ -15,100,000
Year 1 cash flow	$ 5,400,000
Year 2 cash flow	$ 8,900,000
Year 3 cash flow	$ 8,600,000
Debt issue	$ 8,700,000
Debt interest rate	9%

Answer 1

Debt amount = 8700000
Interest rate=	9%
Debt repayment schedule
Year	Op	Interest	Principal payment	Interest payment	Total PAyment	Closing
1	8700000	783000	2900000	783000	3683000	5800000
2	5800000	522000	2900000	522000	3422000	2900000
3	2900000	261000	2900000	261000	3161000	0
CASHFLOW
Year	Cashflow	Less Tax@40%	Cashflow after tax	Tax benefit on Interest	Debt payment	Net Cashflow	DF@16%	PV
0	-6400000					-6400000	1	-6400000
1	5400000	2160000	3240000	313200	3683000	-129800	0.862069	-111897
2	8900000	3560000	5340000	208800	3422000	2126800	0.743163	1580559
3	8600000	3440000	5160000	104400	3161000	2103400	0.640658	1347559
								-3583778
Here the Net Present value comes to negative & hence comppany should not expand the project