Question

You are opening a carnival. Building the carnival will cost $15M dollars, and the carnival will produce EBIT of $3M per year for the foreseeable future. Your tax rate is 28%, your cost of unlevered equity is 11%, and your cost of debt is 6%. In order to boost teen employment, the State of Kansas is offering you an $8M perpetual loan with an interest rate of 5%, but applying for this loan will incur administrative costs of $500,000.

**1)** What is the NPV of this amusement park if
you do not accept the loan?

**2)** What is the NPV of the loan you are being
offered?

**3)** What is the NPV of this project using the
APV method?

Answer #1

Answer-1

NPV or Net Present Value = PV of the Cash Inflow discounted at Cost of capital- PV of the cash out flow discounted at Cost of capital

If no loan is to be used then the Cost of capital = Cost of unlevered equity = 11%.

EBIT | $3000000 |

Less-Interest | $0 |

EBT or earning Before tax | $3000000 |

[email protected]% | ($840000) |

Net cash inflow during year | $2160000[ for foreseeable future] |

Present value of the Foreseeable cash flow = Cash flow / cost of capital

=> Present value of the Cash inflow= $19636364.

Present value of cash inflow | $19636364 |

Present valueof cash out flow | $15000000 |

NPV | $4636364 |

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