Consider a project to produce solar water heaters. It requires a $10 million inv

Question

Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.63 million per year for 10 years. The opportunity cost of capital is 10.25%, which reflects the projects business risk.

a. Suppose the project is financed with $5 million of debt and $5 million of equity. The interest rate is 6.25% and the marginal tax rate is 35%. The debt will be paid off in equal annual installments over the projects 10-year life. Calculate APV. (Do not round intermediate calculations. Roundup your answer to the nearest whole dollar.) What is the Adjusted present value?

b. If the firm incurs issue costs of $300,000 to raise the $5 million of required equity. Calculate APV. (Do not round intermediate calculations. Roundup your answer to the nearest whole dollar.) What is the Adjusted present value?

Explanation / Answer

a)

NPV

= -10 + 1.63 * [1-(1+0.1025)^-10]/0.1025

= -91023

PV of debt advantage

= (0.35 tax rate ($5 debt * 0.0625 debt int.)) / (1

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