Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 6.1 percent
ID: 2769324 • Letter: D
Question
Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 6.1 percent loan with gross proceeds of $5,300,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 2 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 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 answer to 2 decimal places, e.g., 32.16.) Net present value $
Explanation / Answer
(a) Computation of the net present value of the loan excluding flotation costs.We have,
Gross proceeds = $ 5,300,000
Interest rate = 6.1%
Interest amount per year = 5,300,000 x 6.1% = $ 323,300
Interest amount per year after tax = 323,300 x (1 - 0.40) = $ 193,980
Since, the principle and interest amount must pay within 10 years.
After-tax present value of payments = 193,980 x PVIFA(6.1%,10 year) + 5,300,000 /(1.061)10
After-tax present value of payment = 193,980 x 7.3253 + 5,300,000 x 0.55315
After-tax present value of payment = 1,420,961.69 + 2,931,695 = $ 4,352,656.69
NPV = Gross proceeds - Present value of interest and principal payment
NPV = 5,300,000 - 4,352,656.69 = $ 947,343.31
(b) Computation of the NPV of the loan including flotation costs.We have,
Flotation costs = 2% of gross receipts
Flotaiton costs = 2% x 5,300,000 = $ 106,000
Proceeds net of flotation costs = 5,300,000 - 106,000 = $ 5,194,000
Interset costs = 5,194,000 x 6.1% = $ 316,834
After-tax interest cost = 316,834(1-0.40) = $ 190,100.40
After tax present value of payment = 190,100 x 7.3253 + 5,194,000 x 0.55315
After tax present value of payment = 1,392,539.53 + 2,873,061.10 = $ 4,265,600.63
Present value of flotation cost tax shield = (106,000/10) x 0.40 x 7.3253 = $ 31,059.27
NPV = Net proceeds - Present value of interest and principle payment + Present value of flotation cost tax shield
NPV = 5,194,000 - 4,265,600.63 + 31,059.27
NPV = $ 959,458.64
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