Question

Digital Organics (DO) has the opportunity to invest $0.94 million now (t = 0) and expects after-tax returns of $540,000 in t = 1 and $640,000 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 $240,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.40 per dollar of interest paid. Calculate the project’s APV.

Answer 1

NPV- unlevered = 540000/1.13+640000/1.13^2-940000 =	$     39,089.98
Add: PV of interest tax shield = 8640/1.09+4506.03/1.09^2 =	$     11,719.24
Adjusted PV	$     50,809.22	Answer
CALCULATION OF LOAN INSTALMENTS AND INTEREST:
Loan instalment = 240000*0.09*1.09^2/(1.09^2-1) =	$ 1,36,432.54
First year interest = 240000*9% =	$     21,600.00
Tax shield on 1st year interest = 21600*0.40 =	$       8,640.00
Second year interest = (240000+21600-136432.54)*9% =	$     11,265.07
Tax shield on 2nd year interest = 11265.07*0.40 =	$       4,506.03