Question

A project has an unlevered NPV of $1.5 million. To finance the project, debt is being issued with associated flotation costs of $60,000. The flotation costs can be amortized over the project's 5-year life. The debt of $10 million is being issued at the market interest rate of 10 percent paid annually, with principal repaid in a lump sum at the end of the fifth year. The firm's tax rate is 21 percent. What is the project's adjusted present value (APV)?

Answer 1

NPV = $1.5 million

Flotation cost per period = $60000/5 =$12000

Tax saving per period = 12000*.21 = $2520

NET PV of flotation cost = -$60000 + 2520 *(1 /1.1 + 1/1.1^2 + 1/ 1/1^3 + 1/ 1.1^4 + 1/1.1^5) = -$50447.21734

Inerest tax shield = 10000000 *(0.1) * (0.21) =$210000

PV of interest tax shield =$210000 * (1/1.1 + 1/1.1^2 + 1/1.1^3 +1/1.1^4 + 1/1.1^5) = $796065.2216  

Also,

NET PV of loan = Amount borrowed - PV(after tax payment) - PV (principal)

= 10000000 -10000000 * (1-0.21) *(0.1) *( 1/1.1 +1/1.1^2 +1/1.1^3 +1/1.1^4 +1/1.1^5) -10000000/1.1^5

= 10000000 -2994721.548 - 6209213.231

= $ 796065.221

Hence,

APV = $1500000 + $796065.2216 - $50447.21734

APV = $2245618.004 Answer