Digital Organics (DO) has the opportunity to invest $0.93 million now ( t = 0) a

Question

Digital Organics (DO) has the opportunity to invest $0.93 million now (t = 0) and expects after-tax returns of $530,000 in t = 1 and $630,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $230,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.25 per dollar of interest paid. Calculate the project

Digital Organics (DO) has the opportunity to invest $0.93 million now (t = 0) and expects after-tax returns of $530,000 in t = 1 and $630,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 14% with all-equity financing, the borrowing rate is 10%, and DO will borrow $230,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.25 per dollar of interest paid. Calculate the project

Explanation / Answer

Project APV = Net Present value of the returns of the project financed through equity + Net Present value of benefits through debt financing

Net Present value of the returns of the project financed through equity

930000 - 530000/(1+14%)^1-630000/(1+14%)^2

930000- 464912.28 - 484764.54

= - 19676.82

Net Present value of benefits through debt financing

Interest rate has been charged according to the principle amount due to be paid each year :

Ist Installment schedule                                                                  

Second Installment schedule

Net Present value of benefits through debt financing

230000 - 132250/(1+10%)^1 - 123625/(1+10%)^2

=230000 - 120227.30 - 102169.40

= 230000 - 222396.69

= 7603.31

APV = - 19676.82 + 7603.31

APV= -12073.51

Interest rate 10%           Tax rate 25% Interest rate 23000 Tax Shield 5750 Effective Interest 17250 Loan installment 115000      

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