Digital Organics (DO) has the opportunity to invest $0.97 million now (t = 0) an

Question

Digital Organics (DO) has the opportunity to invest $0.97 million now (t = 0) and expects after-tax returns of $570,000 in t = 1 and $670,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 11% with all-equity financing, the borrowing rate is 7%, and DO will borrow $270,000 against the project. This debt must be repaid in two equal installments. Assume debt tax shields have a net value of $0.20 per dollar of interest paid. Calculate the project’s APV. (Do not round intermediate calculations. Rounddown your answer to the nearest whole dollar.)

Explanation / Answer

APV = NPV of Unlevered Cash Flows + PV of Tax Shields

NPV of Unlevered Cash Flows Year Cash Flow PV Discount Factor @ 11% Present Value 0 -$950,000 1 -$950,000 1 $570,000 0.9009 $513,513.51 2 $670,000 0.8116 $543,787.03 NPV $107,300.54 PV of Tax Shields Year Borrowing Interest 7% Tax = $0.20 per dollar of interest paid PV Discount Factor @ 11% Present Value 1 $270,000 $18,900 $3,780 0.9346 $3,532.71 2 $135,000 $9,450 $1,890 0.8734 $1,650.8 PV of Tax Shields $5,183.51 APV = NPV of Unlevered Cash Flows + PV of Tax Shields APV = $107,300.54 + $5,183.51 $112,484.05

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