Question

The company wants to invest a project with the following cash flows: Year 0 : -8000000...

The company wants to invest a project with the following cash flows:

Year 0 : -8000000 Year 1: 5250840 Year 2: 6250840

The firm has a corporate tax rate of 35 percent.The opportunity cost is 12 percent and the debt rate is 6 percent.

Calculate the APV at Year 0 assuming that in every year the optimal debt capacity of the firm is increased by 30 percent of the project’s base-case PV and this is the only financing side effect.

The question does not provide details about equity and debt sharings, so I think WACC might not work. Maybe should use APV = base-case NPV + PV(tax shield) ?

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Answer #1

APV = base-case NPV+PV( financing side effect)

Base-case NPV = -8000000+5250840/(1+12%)+6250840/(1+12%)^2 = 1671381

Assuming it as an all debt project and debt would be paid back in 2 equal installments.

Installments = 8000000*6%/(1-(1+6%)^2) = $ 4363495

Interest for first year = 6%*8000000= $ 480000

tax Shield for first year= 480000*(35%) = $ 168000

Principal remaining = 8000000-4363495+480000 = 4116505

Interest for second year = 6%*4116505 = 246990

tax shield for second year= 246990*(35%) = 86447

PV of Tax shield = 168000/(1+12%)+86447/(1+12%)^2 = 218915

Adjusted present value(APV) = 1671381+218915 = $ 1890296

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