Question

Roger has a levered cost of equity of 0.24. He is thinking of investing in a project with upfront costs of $8 million, which pays $2 million per year for the next 3 years. He is going to borrow $5 million to offset the startup costs at a rate of 0.04. His tax rate is 0.4. He will repay this loan at the end of the project. What is the NPV of this project, using the FTE method?

Answer 1

NPV COMPUTATION USING FLOW TO EQUITY APPROACH:

The Initial step is to calcualte the Levered Cash Flows

Levered Cash flow = Unlevered Cash Flows - [(1-Tax rate) * Debt * Int]

=2,000,000 - [(1-.4) * 5,000,000 * .04]

=2,000,000-120,000

Levered Cash Flows =1,880,000

Levered Cost of Equity = 24%

We will discount Levered Cash Flows with Levered cost of equity

PV of LCF1 = 1,880,000/(1.24)^1= 1,516,129.03

PV of LCF2= 1,880,000/(1.24)^2= 1,222,684.70

PV of LCF3= 1,880,000/(1.24)^3= 986,036.05

SUM of PV of LCFs = 3,724,849.79

NPV as per FTE approach = PV of LCF's - Initial Equity Outlay

= 3,724,849.79 - 3,000,000 = 724,849.79