Question

Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.69 million per year for 10 years. The opportunity cost of capital is 11.25%, which reflects the project’s business risk. a. Suppose the project is financed with $7 million of debt and $3 million of equity. The interest rate is 7.25% and the marginal tax rate is 21%. An equal amount of the debt will be repaid in each year of the project's life. Calculate APV. (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number.) b. If the firm incurs issue costs of $600,000 to raise the $3 million of required equity, what will be the APV? (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations. Round your answer to the nearest whole number. Negative amount shoud be indicated by a minus sign.)

Answer 1

a.)

Base-case NPV=CF₀₊V^u

=-.15 or -$150,000

APV = Base-case NPV + PV(tax shield)

PV(tax shield) is computed from the following table (rd is used to discount):

Year	Bebt Outstanding at EOY	Interest	Interest Tax Shield	Present Value of Tax Shield
0	7000.00
1	6300.00	507.50	106.58	99.37
2	5600.00	456.75	95.92	83.39
3	4900.00	406.00	85.26	69.11
4	4200.00	355.25	74.60	56.39
5	3500.00	304.50	63.95	45.06
6	2800.00	253.75	53.29	35.01
7	2100.00	203.00	42.63	26.12
8	1400.00	152.25	31.97	18.26
9	700.00	101.50	21.32	11.35
10		50.75	10.66	5.29
			Total	449.36

APV=-150,000 + $449,360 = $299,360

.

B.)

APV=Base-case NPV + PV(tax shield) - equity issuance costs

=-150,000 + $449,360 - $600,000

=-$600,640