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 $1.73 million per year for 10 years. The opportunity cost of capital is 11.75%, which reflects the projects business risk.

Suppose the project is financed with $7 million of debt and $3 million of equity. The interest rate is 7.75% and the marginal tax rate is 34%. 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.)

If the firm incurs issue costs of $600,000 to raise the $3 million of required equity. Calculate APV. (Do not round intermediate calculations. Roundup your answer to the nearest whole dollar.)

Suppose the project is financed with $7 million of debt and $3 million of equity. The interest rate is 7.75% and the marginal tax rate is 34%. 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.)

Explanation / Answer

Interest rate net of tax = 7.75% * (1 - .34) = .05115

Annual loan installment:

PV = A*(1-(1+i)^-n)/i

7000000 = A*(1-(1+.05115)^-10)/.05115

A = 911602

APV calculation:

PV of annual cash inflows = 1.73*(1-(1+.1175)^-10)/.1175

= 10 million

PV of annual loan installments = 911602*(1-(1+.1175)^-10)/.1175

= 5,203,896

APV = -3,000,000 + 10,000,000 - 5,203,896

= 1,796,104

b) APV = -3,000,000 + 10,000,000 - 5,203,896 - 600000

= 1,196,104

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