Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 5.50 percent
ID: 2752137 • Letter: D
Question
Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 5.50 percent loan with gross proceeds of $5,950,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 1.40 percent of gross proceeds and will be amortized using a straight-line schedule over the 10-year life of the loan. The company has a tax rate of 40 percent, and the loan will not increase the risk of financial distress for the company.
a.
Calculate the net present value of the loan excluding flotation costs. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Net present value
$
b.
Calculate the net present value of the loan including flotation costs. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Net present value
$
Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 5.50 percent loan with gross proceeds of $5,950,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 1.40 percent of gross proceeds and will be amortized using a straight-line schedule over the 10-year life of the loan. The company has a tax rate of 40 percent, and the loan will not increase the risk of financial distress for the company.
Explanation / Answer
a)NPV of Loan= Gross Proceeds – After-tax present value of interest and principal payments
Gross proceeds=$5,950,000
interest payment =5.5%*5950000=$327,250
Since interest is tax deductible , after tax amount is =(1-0.4)*327,250=$196,350
After tax PV of principal & interest= 196,350*(1-[(1+r)^-n])/r +595000/(1+r)^10
Here r=5.5% and n=10
=1,480,013+3,483,312
=$4,963,325
NPV of loan=5,950,000-4,963,325= $986,675
b)NPV of Loan= (Proceeds net of flotation costs) – (After-tax present value of interest and principal payments) + (Present value of the flotation cost tax shield)
Gross proceeds=$5,950,000
Proceeds net of flotation costs=5950000-(1.4%*5950000)=$5,866,700
interest payment =5.5%*5950000=$327,250
Since interest is tax deductible , after tax amount is =(1-0.4)*327,250=$196,350
After tax PV of principal & interest= 196,350*(1-[(1+r)^-n])/r +595000/(1+r)^10
Here r=5.5% and n=10
=1,480,013+3,483,312
=$4,963,325
Present value of the flotation cost tax shield:
Annual floating costs= 83,300/10=$8,330
Annual tax sheild= 0.4*8330=$3,332
PV of flotation tax sheild=3332*(1-[(1+r)^-n])/r
here r=5.5% and n=10
=$25,115.4
NPV of loan=5,866,700-4,963,325-25,115.4
=$878,259.85
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