Digital Organics (DO) has the opportunity to invest $1.13 million now (t = 0) and expects...

Digital Organics (DO) has the opportunity to invest $1.13 million now (t = 0) and expects after-tax returns of $710,000 in t = 1 and $810,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 13% with all-equity financing, the borrowing rate is 9%, and DO will borrow $290,000 against the project. This debt must be repaid in two equal installments of $145,000 each. Assume debt tax shields have a net value of $.40 per dollar of interest paid.

Calculate the project’s APV. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number.)

Adjusted present value $

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Expert Solution


Calculation of Present value of Investment
cost of equity = 13%
		P.V.F. @ 13%	Present value
Cash flow at year 0	-1130000	1	-1130000
Cash flow at year 1	710000	0.8849557522	628318.5841
Cash flow at year 1	810000	0.7831466834	634348.8135

NPV =			132667.3976

Calculation of Present value of debt tax shield
cost of debt = borrowing rate * (1-t)
9%*(1-0.40) =	5.40%
	Principal remaining	Interest amount@9%	Tax shield = Int. * 0.40	P.V.F. @ 5.4	P.V.
Interest for 1 year	290000	26100	10440	0.9487666034	9905.12334
Interest for 2 year	145000	13050	5220	0.9001580678	4698.825114

Present value of debt tax shield					14603.94845

Adjusted present value = Net Present value with equity fiancing + Present value of Debt tax shield
132667.3976	14603.94845
147271.3461

So, Adjusted present value is $147271.35

Note : To calculate NPV, discount rate of equity shall be used.
To calculate present value of debt tax sheild, cost of debt shall be used.

jeff jeffy answered 7 months ago

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