Question

Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $137 million. The equipment will be fully depreciated using the straight-line method over its economic life of five years. Earnings before interest, taxes, and depreciation collected from the toll road are projected to be $21.3 million per annum for 20 years starting from the end of the first year. The corporate tax rate is 23 percent. The required rate of return for the project under all-equity financing is 15 percent. The pretax cost of debt for the joint partnership is 8.1 percent. To encourage investment in the country’s infrastructure, the U.S. government will subsidize the project with a $55 million, 15-year loan at an interest rate of 4.6 percent per year. All principal will be repaid in one balloon payment at the end of Year 15.

  

What is the adjusted present value of this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

Answer 1

Adjusted present value of this project will be net present value of project cash flows with Full equity financing assumptions and net present value of side effects if financed through debt. Using this approach APV will be:

APV = N.P.V.(Full Equiity) + N.P.V.(Side Effects of Debt financing)

The N.P.V. for an Full equity firm is:

NPV (Full Equity)

NPV = –Init. Investment + Present Value[(1 – tax)(EBITD)] + Present Value (Depreciation Tax Shield)

Using straight line method with 5 yrs life and 0 salvage value annual depreciation expense is:

Annual depreciation = $137,000,000/5

Annual depreciation = $27,400,000

NPV = –$137,000,000 + (1 – .23)($21,300,000)PVIFA15%,20 + (.23)($27,400,000)PVIFA8.1%,5

NPV = –$9,244,824.27

NPV (Side Effects of Debt financing)

Net present value of debt financing side effects will be arrived at by discounting the after tax cash flows from debt financing, and debt repayment.

NPV = Debt amount – After-tax PV(Interest expense) – PV(Principal Repayments)

NPV = $55,000,000 – (1 – .23)(.046)($55,000,000)PVIFA8.1%,15 – $55,000,000/1.08115

NPV = $21,327,355.47

So, the APV of the project is:

APV = N.P.V.(Full Equiity) + N.P.V.(Side Effects of Debt financing)

APV = –$9,244,824.27 + $21,327,355.47

APV = $12,082,531.21