Question

A new firm requires an initial investment of $500 and will generate a before-tax gross return of $590 after one year. The firm is partially financed with $200 of debt at an expected return of 4%. The appropriate unlevered after-tax cost of capital is 14% and the marginal income tax rate is 21%.

1. What is the expected after-tax cash flow for an all-equity firm?

2. What is the APV?

Answer 1

1

after tax cash flow = gross cash flow*(1-tax rate) = 590*(1-0.21)=466.1

2

Discount rate	14.000%
Year	0	1	2
Cash flow stream	-500	466.1	0
Discounting factor	1.000	1.140	1.300
Discounted cash flows project	-500.000	408.860	0.000
NPV = Sum of discounted cash flows
NPV Project =	-91.14
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

APV = NPV + debt*interest*(1-tax rate)/(1+interest)

=-91.14+200*0.04*0.35/0.04

= -21.14