Question

Wilma is considering opening a widget factory. The unlevered
cost of equity for making widgets is 0.13. This factory would cost
$27 million to set up, and would produce EBIT of $3 million per
year for the foreseeable future. She is thinking of applying for a
$3 million subsidized perpetual loan to finance this project.
Complying with the auditing requirements of this loan would have a
present value of $2 million. This loan would have a rate of 0.04,
while the rate she could get from the bank is 0.08. Her tax rate is
0.42. What is the NPV of this project, using the APV method? Answer
should be **-13,485,385,** how do you get there?

Answer #1

Present value using apv = value of unlevered company + present value of interest tax shields

Value of unlvered company = cash flows each year till per perpetuity / cost of equity

Cash flow eac year = EBIT * ( 1 - Tax rate )

= 3 * ( 1 - 0.42)

= $1.74 million

Value of unlvered company = 1.74 / 0.13 * 1000000 = $13384615.38

Interest = value of loan * interest rate = 2 * 0.04 = 0.08

Interest tax shield = interest * tax rate = 0.08* 0.42 = 0.0336

Present value of interest tax shield = Interest tax shield / rate on similar loans

= 0.0336 / 0.08 * 1000000

= 420000

Present value using APV = 13384615.38 + 420000 = 13804615.38

NPV = Present value using APV - cash outflow

= 27000000 - 13804615.38

= **$ 13,195,385**

Wilma is considering opening a widget factory. The unlevered
cost of equity for making widgets is 0.13. This factory would cost
$27 million to set up, and would produce EBIT of $3 million per
year for the foreseeable future. She is thinking of applying for a
$3 million subsidized perpetual loan to finance this project.
Complying with the auditing requirements of this loan would have a
present value of $2 million. This loan would have a rate of 0.04,
while...

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)...

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