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
Less-Tax@28%	($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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