Question

A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0)....

A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0). (A negative answer should be indicated by a minus sign. Enter your answers in dollars, not millions of dollars.)

a. If the firm invests, it has to raise $690,000 by a stock issue. Issue costs are 19.75% of net proceeds. What is the project’s APV?

b. If the firm invests, there are no issue costs, but its debt capacity increases by $690,000. The present value of interest tax shields on this debt is $95,000. What is the project’s APV?

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Homework Answers

Answer #1

a). Solution :- Adjusted present value (APV) of Project = Cost of project + Base case NPV + Net amount raised by stock issue.

= 1000000 + 0 + 690000 * (1 - 0.1975)

= 1000000 + 0 + 690000 * 0.8025

= 1000000 + 553725

= $ 15,53,725.

b). Solution :- Adjusted present value (APV) of Project = Cost of project + Base case NPV - Increase in debt amount + Present value of tax shield on interest portion on the debt.

= 1000000 + 0 - 690000 + 95000

= $ 405000.

Conclusion :-

a). Adjusted present value (APV) of Project $ 15,53,725.
b). Adjusted present value (APV) of Project $ 405000.
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