Question

Tolchester Marina invests in a project to improve its facilities. The upfront investment is $2.5 million. The improvements will lead to an increased operating cash flow of $225,000/year forever. The cost of capital is 10%. The base-case NPV of the project is?

Tolchester is able to borrow $2 million to finance the project. Its borrowing rate is 6%. Tolchester pays state and local taxes at 30%. If the debt is perpetual, the NPV of financing is?

The APV (adjusted present value) of Tolchester's project is?

Based on the APV of the project, Tolchester should accept the project?

Yesterday the value of Tolchester was $10 million. The firm invested in the project this morning at 9:00 am. Today, at 9:05 am, the value of the Tolchester is?

The market value leverage ratio of Tolchester's project is?

Answer 1

Net present value (NPV):
= Present value of cash inflows-Present value of cash outflows
= $225,000/10% - $2,500,000
= $2,250,000-$2,500,000
= -$225,000
Hence, base case NPV is -$225,000
NPV of financing:
= $2,000,000×30%
= $600,000
Hence, NPV of financing is $600,000
APV:
= -$225,000+$600,000
= $375,000
Hence, APV is $375,000
Based on APV accept project.
Value of Tolchester at 9:05 am:
= $10,000,000+$375,000
= $10,375,000
Hence, Value of Tolchester at 9:05 am is $10,375,000
Market value leverage ratio:
= $2,000,000/$10,375,000
= 0.193
Hence, Market value leverage ratio is 0.193